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Institute of Certified Management Accountants of Sri Lanka Integrative Case Study
Serial No………………
© Copyright Reserved
Institute of Certified Management Accountants of Sri Lanka
Level 5 – May 2014 Examination
Examination Date :
Examination Time:
18th May 2014
1.30 p:m. – 4.30 p:m.
Number of Pages
:
Number of Questions:
12
08
Instructions to candidates:
1.
2.
3.
Time allowed is three (3) hours.
Attached to the question are Scenario I given in advance and Scenario II
The answers should be given in English language.
Subject
Subject Code
Integrative Case Study
(ICS - 405)
Question (100 Marks)
Bestfit Clothing
You are required to:
1.
Discuss the present problems prevailing at the production plants and suggest ways of improving the
production efficiency and capacity planning.
(10 Marks)
2.
Explain possible internal transfer pricing issues and give suggestion to overcome such issues from the
company point of view.
(10 Marks)
3.
Explain possible transfer pricing issues that would arise between the parent company and the
proposed entity in Sri Lanka if the new investment proposal would be successful.
(10 Marks)
4.
Discuss on Corporate Social Responsibility engagement possibilities for Bestfit Clothing and their
consequences.
(10 Marks)
5.
Write a report to the management indicating the impact of external environment on the success of the
business if the new investment will be launched in Sri Lanka.
(15 Marks)
6.
Analyze the value chain of Bestfit and explain the ways of reducing the cost of production.
(15 Marks)
7.
Assess the success of manufacturing “Ski Gloves” in Sri Lanka and exporting them to foreign markets.
8.
(15 Marks)
Compute the intrinsic value of a share of Bestfit as the management is proposing to establish an
Employee Share Ownership Programme (ESOP) within the group.
(15 Marks)
(Total 100 Marks)
Institute of Certified Management Accountants of Sri Lanka
Level 5 - Integrative Case Study (ICS – 405) – May 2014 Examination
1
Bestfit Clothing
Scenario I
Bestfit Clothing
Bestfit Clothing commenced its operations in 1955 in UK and manufactures different types of
garments. The major shareholder, Roger took the business in 1985 from his farther who was
considered to be an autocratic leader. Roger did not have adequate managerial experiences until he
started steering the business. Bestfit has two main production divisions namely North and West. North
Division is managed by Bryan and the West Division is managed by Clerk. The organization structure
of Bestfit is given in figure 1.
Figure 1: Organization Structure
Bestfit had 100 employees and produced 1000 garments a week by 1985 and now it has 150
employees. The combined output of the two divisions to external markets averages 6000 garments per
week. The two divisions have totally separate markets. North division supplies own-brand clothing to
tight specifications to a number of supermarket chains whereas West division sells fashion clothing
directly from concessions in a number of specialist retail outlets.
The source raw materials for both types of customers are the same. Top quality fabrics using manmade fibres are imported directly from Italy, since UK suppliers have been found to be inconsistent in
both quality of product and reliability of delivery. The basic operations for both product types are
undertaken at North Division with the unsophisticated garments transferred to West Division for
customizing and repackaging. Figure 2 shows the flow of production, anticipated time lags between
processes and time taken for each process.
Institute of Certified Management Accountants of Sri Lanka
Level 5 - Integrative Case Study (ICS – 405) – May 2014 Examination
2
Figure 2: Production Process and Time Lags
Machi
ning
(2)
North Division
24
Raw
Materi
als IN
4
Store
Issues
(0.5)
Cutt
ing
(2)
16
Butto
nholin
g
(1)
4
4
Insp
Pre
32
ectio
ssin
n
g
(0.5)
(1)
4
Fold
ing
(0.5
)
4
Pa
cka
gin
g
8
Dist
ribu
tion
(0.5)
4
Pocketin
g
(1)
2
Distributio
n
2
Panel
ing
(1)
2
Raw
Materials
-IN
2
Machi
-ning
(2)
4
Stitchin
g
(1)
2
Inspec
-tion
(1)
4
2
West Division
Edgi
ng
(1)
Pressing
(1)
2
Folding
(0.5)
2
Packaging
(0.5)
Normal Lead time
==
Processing
Time
2
Distributi
-on
4
( )
The specialty line of the West division originally began as a ‘good idea’ for a diversification which did not
require huge investment. It was so successful in the period following 1985 that it quickly provided the majority
of Bestfit’s turnover and profits.
Lack of investment in the North division plant has severely constrained the growth of direct sales through West
division. Production bottlenecks in the cutting and pressing departments have caused long delays and given
West division the unfortunate reputation of an unreliable supplier. The manager of West division is particularly
upset since he feels that the consequent lost orders and sales reflect on him as a manager. He has urged
managing director, so far without success, to allow him to source outside of the company for the basic West
division materials.
Institute of Certified Management Accountants of Sri Lanka
Level 5 - Integrative Case Study (ICS – 405) – May 2014 Examination
3
The problem has been exacerbated since 2007, when the head of marketing and design, initiated an aggressive
marketing policy designed to increase Bestfit’s penetration in the supermarket end of the business. The success of this
marketing ploy has seen Bestfit gears up for bigger orders to more end-users of the basic North division products. In
consequence, the manager of the West Division had received a falling percentage share of the North division’s
products, which has prevented West division from growing similarly despite the apparent demand. He is frustrated
about the present situation. Table 1 reveals divisional revenue and profits for past 6 years.
Table 1: Revenue and profit
2007
Revenue
(US$ mn)
-North
-West
Profit US$
mn
-North
- West
2008
2009
2010
2011
2012
1.68
0.72
2.4
2.1
1.4
3.5
2.2
1.8
4
2.08
3.12
5.2
2.4
5.6
8
2.4
7.2
9.6
0.064
0.016
0.08
0.09
0.03
0.12
0.091
0.049
0.14
0.0935
0.0765
0.17
0.1125
0.1375
0.25
0.12
0.18
0.3
A system of transfer pricing operates between the divisions, governing the price of material inputs to the West
division for the purpose of internal profit calculation. West division currently pays a transfer price of US$23 per
garment, a figure which, Clerk, the manager of west division considers too high and far higher than he would have to
pay for outside sourcing. However, Bryan justifies the transfer price on the basis of his cost calculations.
Clerk West further, argues that neither overheads nor any mark-up of North division should include in the transfer
price, while Bryan is adamantly saying that the existing overhead allocation is well below what is relevant and
appropriate for the output up to the level at which it is transferred. The average cost structure per garment is given in
table 2.
Table 2: Cost per Garment
North
Transfer In
Raw Materials $
Direct Labour Hours (7*$2)
Machine Time (4*$1)
Overheads
Mark-up
Transfer Price to West
Market Price
3
14
4
1
1
23
West
23
(8 × $2)
(6 × $1)
16
6
1
4
50
In addition to the garment item explained T-shirts and blouses have been introduced to the production lines recently.
T-shirts are made of single jersey combed cotton. This special cotton is harvested, ginned and spun into yarn in the
USA. The yarn is shipped to UK for manufacturing of T-shirts. In the USA, this has led to investment in advanced
biotechnologies, including genetically modified (GM) seeds, intensive use of chemicals and a high degree of
automation in order to mitigate the risk of vulnerability to disease and due to the fact that growth is dependent on
uncontrollable factors like the weather. This has allowed USA cotton farmers to overcome the disadvantage of high
labour costs and at present the USA is the largest producer of cotton in the world.
Blouses are made from man-made (viscose) fibres. This is manufactured and sold as a fashion item rather than a basic
item. Viscose is an example of a regenerated (manmade) fibre made out of cellulose. Table 3 gives the cost and price
structure of these two products.
Institute of Certified Management Accountants of Sri Lanka
Level 5 - Integrative Case Study (ICS – 405) – May 2014 Examination
4
Table 3: Cost and Price
Fabric
Other Accessories and Labour
Overheads
Manufacturing Cost
Whole sale price
Retail Price
T-Shirt $
0.55
1.08
0.37
2.00
2.75
7.00
Blouse $
0.7
1.55
1.00
3.25
7.00
22.00
Global Overview of the Industry
The world’s expenditure on clothing and textile per annum now exceeds US dollars 1 trillion. Western
Europe and North America each accounts for 30% of total sales. The Asia accounts for about 25% of
sales while the balance 15% takes place in the rest of other countries around the world. With respect to
global exports, clothing and textiles represent about eight per cent of world exports. The workforce in
clothing and textiles industry around the world was more than 27 million by 2012.
The production statistics reveal that more than 25% of the world’s clothing and textiles production
takes place in China. The USA is the major cotton exporter and the figure 3 gives a summary of cotton
exports.
Figure 3: Cotton Exports-2012
The production volume has been growing while the prices are dropping, as new technology and
business integration increase the productivity and efficiency. Growth in volumes is mainly associated
with use of polyester and natural fibre. The international trade of garments and textiles largely happen
either by international quota agreements and bilateral agreements.
Despite the development of the industry can be seen from many aspects, heavy use of energy and toxic
chemicals in the production processes have become major concerns as they produce negative
environmental impacts. Burning fossil fuel to create electricity for production, heating water and air in
laundering significantly contribute to climate change.
Toxic chemicals are used widely in cotton agriculture and in many manufacturing stages such as pretreatment, dyeing and printing. Waste volumes from the sector are also high and it is aggravated due to
‘fast fashion’ especially in Europe and in Western markets. Consumers in Europe send 50kg of
Institute of Certified Management Accountants of Sri Lanka
Level 5 - Integrative Case Study (ICS – 405) – May 2014 Examination
5
clothing and textiles per capita to landfill each year. The extensive use of water in cotton crop
cultivation can also be seen as a major environmental issue. On the other hand, issues such as poor
working conditions of workers in the industry and low level of salaries in the developing countries
have not yet been addresses satisfactorily.
Retailers in developed countries are increasingly specifying codes of good practices and ethical
conducts in relation to labour standards to their suppliers. In some countries the right of workers in the
sector to form trade unions to represent their concerns in collective bargaining is either prohibited or
suppressed.
Recent survey studies on the future of the sector highlighted the following trends.
 Competition in the sector will increase, as skill levels and investment in developing countries
continues to grow
 Prices in the UK will continue to be driven down
 Innovations may include new production technologies to reduce the labour requirement of
garment completion and development of novel ‘smart’ functions








Pressure from consumers and legislation is likely to drive increasing demands for
environmentally sensitive production
Focus on the use of chemicals but may extend to include re-use of materials and substitution of
alternative materials
International campaigns will continue to drive improvement in working conditions for
employees in developing countries
Reduction of the life of the product and re-use materials through process innovation
A switch from conventional to organic cotton growing
Energy requirements for cotton garments are dominated by washing, drying and ironing
Technology innovations such as 3D knitting and weaving may lead to economically viable
production
Growing pressure to reduce environmental impact and promote social equity
.
Significance of Asian Countries
In the past five to ten years, employment in the sector has increasingly been concentrated in China,
Pakistan, Bangladesh, India, Mexico, Romania, Cambodia and Turkey. However, a global decline in
employment in the sector is seen in countries such as the USA, Europe and the Philippines.
Employment in the clothing and textile sector in EU25 countries fell by one million to 2.7 million from
1995 to 2012. A further one million job losses in the sector are anticipated in the next five years.
However, for many smaller developing countries, which are small exporters on a global scale, clothing
and textiles exports are their dominant form of external earnings. In Bangladesh, Haiti and Cambodia
clothing and textiles account for more than 80% of total exports. Similar high figures apply to the
proportion of the country’s manufacturing workers employed within the clothing and textiles sector.
Strikingly, wage rates in India, Sri Lanka and Pakistan are lower than in China. However, China
continues to dominate the sector because of a build-up of competitive advantages including short lead
times, efficient logistics, a more experienced and skilled labour force, a better power infrastructure and
more investment in capital equipment. Export earnings of some Asian countries from clothing and
Institute of Certified Management Accountants of Sri Lanka
Level 5 - Integrative Case Study (ICS – 405) – May 2014 Examination
6
textiles are significant. The figure 4 indicates the percentage of export earnings from clothing and
textiles.
Figure 4: Export Earnings from clothing and textiles
Developing countries account for almost three quarters of world clothing exports and for half of world
textile exports. Many Asian garment investors drawn by the African Growth and Opportunity Act
(AGOA), a preferential trade agreement signed with the USA, have set up garment factories in Kenya,
Lesotho and Swaziland. However, Africa has seen the worst job losses since the end of the Agreement
of Textiles and Clothing (ATC).
Despite the dominance of the Asian countries, around six million people are employed in the European
and Mediterranean area. Mainly this is due to the trade-off between low labour costs (Asia) and
proximity to developed markets (European-Mediterranean) and companies such as Inditex have
developed new models for clothing supply based on rapid response to changes in fashion with clothing
sourced near to purchase. In Bulgaria the clothing and textiles industry, which has a history spanning
two centuries, retains a competitive advantage over neighbouring countries through cheaper labour.
However, this advantage may be eroded once Bulgaria joins the EU, as imposition of EU rules on
employment and trade may increase costs as has happened in Hungary and Poland. Bulgaria is also
likely to see an increase in imports of cheaper Chinese apparel and textiles as has occurred in Romania
since the phasing out of quotas.
Figure 5 shows the hourly wage rates in the sector as per the statistics of International Labour
organization.
Institute of Certified Management Accountants of Sri Lanka
Level 5 - Integrative Case Study (ICS – 405) – May 2014 Examination
7
Figure 5: Wage Rates in US$
Production Process and Trends
Clothing and textiles products begin as either natural (cotton, silk, wool), man-made (made from cellulosic, e.g.
viscose) or synthetic fibres (oil used to create polymers, e.g. polyester, acrylic and nylon).
Manufacturing process begins with spinning the original fibres into yarns. These yarns are converted into
fabrics, by one of two processes of weaving or knitting. The fabric is then formed into a ‘3D shell’ to be useful
as clothing. From the design of a garment to the pressing and packaging of a finished product a range of
processes are required.
There is continuous development of technology at all levels of these activities aiming at reduced labour intensity
and quicker delivery. However, in 300 years of innovation, no technical substitute has been found for human
hands able to handle and sew all kinds of fabrics, a task that is still complex for robots. Instead, the industry has
relocated in pursuit of cheap labour for which a low paid job performing repetitive tasks in a factory is more
attractive than any of their other options.
However, due to innovations in knitting machines, knitwear is increasingly made by machines. Some other
production technology innovations include laser cutting of fabric, automated sewing machines that ‘learn’
operations from humans and ink jet printing of fabric or made-up garments. Integration of computer aided
design and manufacture in the whole supply chain is being developed to reduce lead times and improve the
quality and performance of products. Recent research in the industry has aimed to transfer technologies from the
automotive industry to use ‘new industrial robotics’ to reduce the need for expensive labour. This is
economically attractive for manufacturers in developed countries with high costs but potentially will remove
important employment opportunities in developing countries. The sector has also seen a rapid adoption of novel
IT solutions for production system control and virtual design, stock control, replenishment and real-time
monitoring of fashion trends.
Different operations, which add value for clothing and textile industry in a technology driven market is given in
figure 6:
Institute of Certified Management Accountants of Sri Lanka
Level 5 - Integrative Case Study (ICS – 405) – May 2014 Examination
8
Figure 6: Technology Platform
UK Market
The UK had a dominant role in the clothing and textiles sector in the early 19th Century but is experiencing a
steady decline mainly due to withdrawal of Marks and Spencers’ demand from UK clothing and textile
manufacturers in the 1990’s. Activity in the sector in the UK is now focused on design more than production.
However, the UK potentially may serve as a source of innovation, particularly for niche or high quality
products. An example of this is the UK’s strength in wool production which has traditionally been recognized
for delivering state of the art goods to international market such as Japan and the USA. The UK is also
developing competitiveness in novel nanotechnology coatings and smart functions to be applied to clothing and
textiles and in the design and manufacture of technical textiles, such as those for protective clothing and medical
use.
Despite the exit of manufacturing in clothing and textiles from the UK, the sector continues to be highly
valuable, as the biggest profits in the sector are at the end of the supply chain in retail and branding. The cost
and price structure of the sector globally is now characterized by there being the potential for high profit from
innovation, marketing and retailing but low profit from sourcing, production, assembly, finishing, packaging and
distribution. In supplying finished goods to end consumers, multiple store retailers dominate this sector by
selling 70% of clothing in Western Europe and 85% in the USA. The top five department stores in the USA
delivered about half of its total sales.
Consumers in UK spend on average £800 per head on clothing and textiles, of which around £625 is on clothes.
Total spending on clothes in the UK in 2012 was £41.6 billion of which £25 billion was on women’s, girls and
infants clothing, £13 billion on men’s and boys’ clothing and the rest is on accessories, hire, cleaning, tailoring,
etc…
Spending on women’s clothing is growing significantly and it increased by about 21% and whereas men’s
clothing spending increased by 14% during the period from 2005 to 2012. The prices dropped by 14% during
the same period of time. The sales increased by increased by 40% thus, showing the number of garments bought
per person in the UK increased by over one third.
Institute of Certified Management Accountants of Sri Lanka
Level 5 - Integrative Case Study (ICS – 405) – May 2014 Examination
9
The major clothing product categories are Trousers, Pullovers, and T-shirts. Combined these three clothing
categories represent about half of the total consumption by mass. One fifth of the UK’s annual consumption by
weight of clothing and textile products is manufactured in the UK. About two-thirds of the UK import of basic
textile materials (fibres, yarns and fabrics) by mass to the industry is man-made, the rest is of primarily cotton
and wool.
Figure 7 shows major inputs and outputs of clothing industry in UK
Figure 7: Major Inputs and outputs of clothing industry
Second-hand clothing
After the consumer use phase the life of a garment or textile product is not over. Some clothes and textiles are taken
to recycling clothes banks operated for example by the Salvation Army, Traid, Oxfam, or many other members of the
Textile Recycling Association. The goods are transported to recycling plants to be sorted. The best quality garments
are sent for resale at charity shops and a small number of items are remanufactured to add value and sold as
fashionable items. However, most are shipped for resale in Eastern Europe, the Middle-East or Africa.
The second-hand clothes trade in developing countries creates some employment and is an important source of low
cost clothing. The trade is only a small fraction of global trade in clothing but in many African countries it has a
significant proportion of the market, up to 30% of the total value of imports and 50% in volume. This raises a concern
that second-hand clothes inhibit the development of local industry. However, at present trade in second-hand clothing
is falling as a share of total clothing imports due to the increase of cheap imports from Asia.
End of Scenario I
Institute of Certified Management Accountants of Sri Lanka
Level 5 - Integrative Case Study (ICS – 405) – May 2014 Examination
10
Scenario II – A continuation of Scenario I
An investment proposal has been forwarded to the board of directors of Bestfit Clothing for its approval. It
proposes an investment of US$ 600 million to run a garment manufacturing establishment in Sri Lanka. The
CEO of Bestfit argues that tax concession for 15 years with other privileges available under the board of
investment (BOI) of Sri Lanka can be obtained if the investment will be successful. He further explains the fact
that the garment industry has been recognized by Sri Lankan government as a strategic investment if it is over
US $ 500 million.
As per BOI requirements, no finished garments are sold in the local market and entire production is exported.
The statistics on cost of production reveal that the cost of a garment in Sri Lanka is relatively low as the labour
cost and other service costs are cheap. Further, the parent company has the freedom of buying raw materials,
and other required accessories from any place as it wishes. Markets can also be determined by the parent
company through its existing networks and alliances that it has already established in addition to possible quota
agreements that are likely to be obtained. Sri Lankan government has already given its approval for the
proposed business as a strategic investment.
However, some board members are concerned about possible risks which are likely to be exposed due to many
factors such as political issues, foreign currency fluctuation, tendency of increasing labour costs, increasing
pressure for environmental issues in manufacturing, cost of environmental compliances, other legal matters and
government strategic priorities aligning with tourism etc…
The proposal further suggests to manufacture “Ski Gloves” for which there is an increasing demand in Europe,
USA, Australia, Japan and China. It says that the production cost of Ski Gloves is relatively high if they are
manufactured in developed countries. Therefore, it would be a strategically important decision for Bestfit to
manufacture ski gloves in a country where the cost of production is low. The market price of Ski Gloves is high
as it is traded in upmarket.
However, one of the non-executive directors has pointed out the fact the diversion of demand for garments
especially in UK and Europe towards used garments will also have a significant impact on the demand for new
garments if the cost cannot be drastically brought down. The trend is to use fewer more durable garments and
textile products. Washing patterns of cloths are also changing and people tend to wash clothes less often, at
lower temperatures to use eco-detergents, hang-dry them and avoid ironing where possible. In additions,
consumers are now highly concerned about some social aspects when buying new garments. For example,
consumers tend to choose garments with least energy use, least toxic emissions, made by workers paid a
credible wage with reasonable employment rights and conditions etc…
On the other hand Bestfit is facing lot of pressures from shareholders to increase the profitability and from the
society and environment on social grounds. Hence, the management of Bestfit is considering the possibilities of
engaging in Corporate Social Responsibility activities where it can engage in efficient energy use, reduction in
the use of toxic chemicals which may harm human health and the environment, reduction of the release of
chemicals in waste water, management of solid waste and disposal of products at the end of their life.
End of Scenario II
Institute of Certified Management Accountants of Sri Lanka
Level 5 - Integrative Case Study (ICS – 405) – May 2014 Examination
11
CMA INTEGRATIVE CASE STUDY – (ICS - 405)
May 2014 Examination – Marking Grid
Marks
1.
2.
3.
4.
5.
6.
Management Accounting
Sound technical knowledge
in Management Accounting
Application of theories
Diverse knowledge clearly
applied in an analytical and
practical manner in solving
the problems in the case
study.
Identifying key issues
Issues to be identified and
prioritized in a logical
manner with a clear
rationale.
Decision making skills
Ability to recognize and
present appropriate
alternate solutions and make
effective judgment in a
logical & rational manner.
Logical arguments
Ability to communicate
effectively with realistic
recommendations in a
concise and logical manner.
Communication skills
Style and synthesis in
evaluation of a good report
to higher management.
20
20
A
High level of
Management
Accounting
awareness relating
to world examples
B
Good Management
Accounting
awareness relating to
case study examples
C
Some level of
Management
Accounting
awareness relating
to few case study
examples
D
Low level
Management
Accounting
awareness
E
Lack of
Management
Accounting
awareness
17-20
11-16
High level of
application of
theory in an
analytical manner
in solving problems
in the case study
10-14
5-9
0-4
Good level of
application of theory
in an analytical
manner solving
problems in the case
study.
Some level of
application of
theory in an
analytical manner
solving problems in
the case study.
Low level of
application of
theory in solving
problems in the
case study
Lack of application
of theory in solving
problems
10-14
5-9
0-4
High level of
recognition of key
issues and these
being prioritized
logically with a
clear rational.
Good level of
recognition of issues
and these being
prioritized logically
Some level of
recognition of
issues and these
being prioritized
Low level of
recognition of
issues
Lack of recognition
of issues
8-10
5-7
3-4
1-2
0
High level of
ability to
recognize and
present
appropriate
alternate solutions
and make
effective
judgment in a
logical and rational
manner
Good level of ability
to recognize and
present alternate
solutions and make
effective judgment
in a logical and
rational manner.
Some level of
ability to
recognize and
present alternate
solutions in a
logical and rational
manner
Low level of
ability to
recognize
alternate solutions
Lack of ability to
recognize
alternate solutions
17-20
11-16
10-14
5-9
0-4
High level of
ability to
communicate
effectively with
realistic
recommendations
in a concise and
logical manner
Good level of ability
to communicate
effectively with
realistic
recommendations in a
concise manner
Low level of
ability to
communicate
effectively
Lack of ability to
communicate
effectively
17-20
11-16
Some level of
ability to
communicate
effectively with
realistic
recommendations
in a concise
manner
10-14
5-9
0-4
High level of
combining ideas
and experiences in
a professional
manner using
relevant
appendixes
Good style in writing
a Management
Report encompassing
ideas and
recommendations
with some
appendixes
Some style in
writing a
Management
Report
encompassing
ideas and
recommendations
Poor style in
writing a
Management
Report
Lack of knowledge
in writing a
Management
Report
1-2
0
17-20
10
20
20
10
8-10
TOTAL
11-16
5-7
8-10
3-4
100
End of Question Paper
Institute of Certified Management Accountants of Sri Lanka
Level 5 - Integrative Case Study (ICS – 405) – May 2014 Examination
12
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