Chapter 6 Decision Making Nov 2020

6 Decision Making
Q1: Catalyst Ltd. Makes a single product with the following details:
Description Current Proposed Change

Situation
Selling Price (`/unit) 10
Direct Costs (`/unit) 5
Present number of setups per production period, 42

(before each production run, setup is done)
Cost per set up (`) 450 Decrease by ` 90
Production units per run 960 1,008
Engineering hours for production period 500 422
Cost per engineering hour (`) 10
The company has begun Activity Based Costing of fixed costs and has presently identified
two cost drivers, viz. production runs and engineering hours. Of the total fixed costs presently
at ` 96,000, after the above, ` 72,100 remains to be analyzed. There are changes as proposed
above for the next production period for the same volume of output.
Required:
(i) How many units and in how many production runs should Catalyst Ltd. produce in
the changed scenario in order to break-even?
(ii) Should ABC Ltd. continue to break up the remaining fixed costs into activity based
costs? Why?
Solution:
Workings
Statement Showing ‘Non-unit Level Overhead Costs’
Particulars Current Situation Proposed Situation
No. of Production Runs/Setups 42 40
960 runs × 42 setup
———————
1,008 units
Particulars Current Situation Proposed Situation
Cost per Setup ` 450 ` 360
Production Units per run 960 units 1,008 units
Production Units 40,320 40,320
(960 units × 42)
Engineering Hrs. 500 422
Engineering Cost per hour ` 10 ` 10
Requirement of Question
(i) Break Even Point (Changed Scenario)
Break Even Point
= 18,144 units
Break Even Point (No of Production Runs)
= 18 Runs
(ii) A company should adopt Activity Based Costing (ABC) system for accurate product
costing, as traditional volume based costing system does not take into account the Non-
unit Level
Overhead Costs such as Setup Cost, Inspection Cost, and Material Handling Cost etc.
Cost Analysis under ABC system showed that while these costs are largely fixed with
respect to sales volume, but they are not fixed to other appropriate cost drivers. If break
up the remaining ` 72,100 fixed costs consist of only a small portion of these costs, ABC
need not be applied.
However, it may also be noted that the primary study has resulted in cost savings. If the
savings in cost are expected to exceed the cost of study and implementing ABC, it may
be justified.
Further it is pertinent to mention that ABC offers no increase in product-costing accuracy
for single-product setting.

Q2: A Manufacturing Company produces ball pens that are printed with the logos of various
companies. Each pen is priced at `5. Coats are as follows:
Cost Driver Unit variable cost (`) Level of cost driver
Units Sold 2.5 -
Setups 225 40
Engineering hours 10 250
Other data
Total fixed cost (conventional) `48,000
Total fixed costs (ABC) `36,500
Required:
(i) Compute the break-even points in units using activity-based ananlysis.
(ii) Suppose that company could reduce the setup cost by `75 per setup and could reduce
the number of engineering hours needed to 215. How many units must be sold to
break even in this case?
Solution: Break Even Points
(i) [Fixed costs + (setup cost x setups) + Engineering Cost x Engineering Hours)]/(sales
price – variable cost)
= [36,500 + (`225 × 40) + (`10 × 215)]/(`5 - `2.5)
= 19,200 units
(ii) [Fixed costs + (setup cost x setups) + Engineering Cost x Engineering Hours)]/(sales
price – variable cost)
= [36,500 + (`150 × 40) + (`10 × 215)]/(`5 - `2.5)
= 17,860 units

(BREAK EVEN POINTS WITH SEMI VARIABLE COST)
Q11: Electro Life Ltd. is a leading Home Appliances manufacturer. The company uses just-
in- time manufacturing process, thereby having no inventory. Manufacturing is done in batch
size of 100 units which cannot be altered without significant cost implications. Although the
products are manufactured in batches of 100 units, they are sold as single units at the market
price. Due to fierce competition in the market, the company is forced to follow market price
of each product. The following table provides the financial results of its four unique products:
Alpha Beta Gamma Theta
Sales (units) 2,00,000 2,60,000 1,60,000 3,00,000 Total
(`) (`) (`) (`) (`)
Revenue 26,00,000 45,20,000 42,40,000 32,00,000 145,60,000
Less: Material Cost 6,00,000 18,20,000 18,80,000 10,00,000 53,00,000
Less: Labour Cost 8,00,000 20,80,000 12,80,000 12,00,000 53,60,000
Less: Overheads 8,00,000 7,80,000 3,20,000 12,00,000 31,00,000
Profit/(Loss) 4,00,000 (1,60,000) 7,60,000 (2,00,000) 8,00,000
Since, company is concerned about loss in manufacturing and selling of two products so, it
has approached you to clear picture on its products and costs. You have conducted a detailed
investigation whose findings are below:
The overhead absorption rate of` 2 per machine hour has been used to allocate overheads into
the above product costs. Further analysis of the overhead cost shows that some of it is caused
by the number of machine hours used, some is caused by the number of batches produced and
some are product specific fixed overheads that would be avoided if the product were
discontinued. Other general fixed overhead costs would be avoided only by the closure of the
factory. Numeric details are summarized below:
Machine hour related 6,20,000
Batch related 4,60,000
Product specific fixed overhead:
Alpha 10,00,000
Beta 1,00,000
Gamma 2,00,000
Theta 1,00,000 14,00,000
General Fixed Overheads 6,20,000
31,00,000
The other information is as follows:—
Alpha Beta Gamma Theta Total
Machine Hours 4,00,000 3,90,000 1,60,000 6,00,000 15,50,000
Labour Hours 1,00,000 2,60,000 1,60,000 1,50,000 6,70,000
Required
(i) Prepare a profitability statement that is more useful for decision making than the
profit statement prepared by Electro Life Ltd.
(ii)Calculate the break-even volume in batches and also in approximate units for
Product‘Alpha’.
Solution
Statement Showing “Profitability of Electro Life Ltd”
Products (Amount in`)
Sales 26,00,000 45,20,000 42,40,000 32,00,000 1,45,60,000
Direct Materials 6,00,000 18,20,000 18,80,000 10,00,000 53,00,000
Direct Wages 8,00,000 20,80,000 12,80,000 12,00,000 53,60,000
Overheads (W.N.2):
Machine Related 1,60,000 1,56,000 64,000 2,40,000 6,20,000
Batch Related 1,00,000 1,30,000 80,000 1,50,000 4,60,000
Contribution 9,40,000 3,34,000 9,36,000 6,10,000 28,20,000
Products (Amount in`)
Product Specific Fixed 10,00,000 1,00,000 2,00,000 1,00,000 14,00,000
Overheads
Gross Profit (60,000) 2,34,000 7,36,000 5,10,000 14,20,000
General Fixed Overheads 6,20,000
Profit 8,00,000
(ii) Break-even Point
Total Sale Value of Product ‘Alpha’ = `26,00,000
Total Contribution of Product ‘Alpha’ = `9,40,000
Specific Fixed Overheads (Product Alpha) = ` 10,00,000
Break-even Sales (`) =
=
=`27,65,957.45
Break-even Sales (units) =

= 2,12,766 units
However production must be done in batches of 100 units.Therefore 2,128 batches are
required for break even. Due to the production in batches, 34 units (2,128 batches × 100 units
– 2,12,766 units) would be produced extra. These 34 units would add extra cost `282.20 (34
units × `8.3*). Accordingly, break-even units as calculated above will increase by 22 units
(*)
Break-even units of product ‘Alpha’ is 2,12,788 units (2,12,766 units + 22 units).
Workings
W.N.-1
Calculation Showing Overhead Rates
Overhead’s Related Overhead Total No. of Overhead Rate
Factors Cost (`) Units of Factors (`)
[a] [b] [a]/[b]
Machining Hours 6,20,000 15,50,000 hrs. 0.40
Batch Production 4,60,000 9,200 batches 50.00
W.N.-2
Statement Showing - Overhead Costs Related to Product
Particulars Alpha Beta Gamma Theta
Machining ` 1,60,000 ` 1,56,000 ` 64,000 ` 2,40,000
hrs. related (4,00,000 hrs× (3,90,000 hrs × (1,60,000 hrs × (6,00,000 hrs ×
overheads `0.40) `0.40) `0.40) `0.40)
Batch Related `1,00,000 `1,30,000 `80,000 `1,50,000
Overheads (2,000 batches (2600 batches × (1,600 batches × (3,000 batches ×
× `50) `50) `50) `50)

Q10: Satish Enterprises is a leading exporter of Kid’s Toys.J Ltd. Of USA has approached
Satish Enterprises for exporting a special toy named “Jumping Monkey”. The order will be
valid for next three years at 3,000 toys per month. The export price of the toy will be $ 4.
Cost data per toy is as follows:
Materials…………………………………………………….`60
Labour……………………………………………………….`25
Variable overheads………………………………………..`20
Primary packing of the toy………………………………..`15
The toys will be packed in lots of 50 each. For this purpose a special box, which will contain
the 50 toys will have to be purchased, cost being` 400 per box. Satish Enterprises will also
have to import a special machine for making the toys. The cost of the machine is` 24,00,000
and duty thereon will be at 12%. The machine will have an effective life of 3 years and
depreciation is to be charged on straight-line method. Apart from depreciation, annual fixed
overheads is estimated at` 4,00,000 for the first year with 6% Increase in the second year.
Fixed overheads are incurred uniformly over the year.
Assuming the average conversion rate to be` 50 per $.
Required
(i) Prepare a monthly and yearly profitability statements for the first year and second
year assuming the production at 3,000 toys per month.
(ii) Compute a monthly and yearly break-even units in respect of the first year.
(iii) In what contingency can there be a second break-even point for the month and for
the year as a whole?
(iv) Have you any comments to offer on the above?
Solution
Profit for First/Second Year on Monthly and Yearly Basis
(Amount in ‘000)
First Year Second Year
Monthly Yearly Monthly Yearly
(`) (`) (`) (`)
Sales Revenue 600 7,200 600 7,200
{3,000 units × ($4 × ` 50)}
Material 180 2,160 180 2,160
(3,000 units × ` 60)
Labour 75 900 75 900
(3,000 units × ` 25)
Variable Overheads 60 720 60 720
(3,000 units × ` 20)
Primary Packing 45 540 45 540
(3,000units × `15)
Boxes Cost 24 288 24 288
Total Fixed Overheads 108 1,296 110 1,320

(W.N.-1)
Profit 108 1,296 106 1,272

Monthly Break-Even Units for the First Year
Levels No. of Units (See W.N.-2)
1,351-1,400 1,401-1,450 1,451-1,500 1,501-1,505
(`) (`) (`) (`)
Fixed Costs:
Total Fixed Overheads 1,08,000 1,08,000 1,08,000 1,08,000
per month
Semi-Variable Costs : 11,200 11,600 12,000 12,400
(Special Boxes Cost) (28 Boxes (29 Boxes (30 Boxes (31 Boxes
(W.N.-2) × `400) × `400) × `400) × `400)
Total Fixed and Semi 1,19,200 1,19,600 1,20,000 1,20,400
Variable Costs
Break-even Level (in 1,490 1,495 1,500 1,505
units)* (`1,19,200 (`1,19,600 (`1,20,000/ (`1,20,400/
/` 80) /` 80) ` 80) ` 80)
Total Fixed and Semi- Variable Cost
———————————————
Contribution per unit
The above statement shows that the first and second break-even level of units, viz., 1,490 and
1,495 units falls outside the range of 1,351 -1,400 and 1,401 -1,450 units respectively. In the
present case a monthly break-even level of units is 1,500 units which lies in the range of
1,451-1,500 units.
Yearly Break-Even Units for the First Year
Levels No. of Units (See W.N.-3)
17,851- 17,901- 17,951- 18,001-
17,900 17,950 18,000 18,050
(`) (`) (`) (`)
Fixed Costs 12,96,000 12,96,000 12,96,000 12,96,000
Semi-Variable Costs 1,43,200 1,43,600 1,44,000 1,44,400
(Special Boxes Cost) (358 Boxes × (359 Boxes × ` (360 Boxes× ` (361 Boxes ×
`400) 400) 400) ` 400)
Total Fixed and Semi 14,39,200 14,39,600 14,40,000 14,40,400
Variable
Costs
Break Even Level (in 17,900 17,995 18,000 18,005
Units) (`14,39,200/ (`14,39,600/ (`14,40,000/ (`14,40,400/
`80) `80) `80) `80)
The above table shows that yearly break-even of units is 18,000 units which lies in the range
of 17,951-18,000 units. The other first two figures do not lie in the respect ranges. Hence,
they are not acceptable.
(i) In case the number of toys goes beyond the level of 1,500, one more box will be
required to accommodate each 50 additional units of toys. In such a case the
additional cost of a box will be ` 400. This amount can be recovered by the additional
contribution of 5 toys. Thus, the second break-even point in such a contingency is
1,505 toys.
In case the number of toys goes beyond the level of 18,000 number, one more box
will be required. The additional cost of this box will be ` 400; which can be recovered
by the additional contribution of 5 toys. Thus, the second break-even point is 18,005
toys.
(ii) Yearly break-even point of 18,000 units of toys in the first year is equal to 12 times
the monthly break-even point of 1,500 units. Thus, both the monthly and yearly
figures of break-even point fall on the upper limit of their respective range.
In the second case, it is not so because the monthly and yearly break-even point fall
within the range of 50 toys.
Working Notes
(1)
Fixed Overheads 1st Year 2nd Year
Depreciation `24,00,000 + `2,88,000 (Duty) ` 8,96,000 ` 8,96,000
3 Years
Other Fixed Overheads `4,00,000 `4,24,000
Total Fixed Overheads `12,96,000 `13,20,000
(2)
Fixed Overhead in the first year 12,96,000
Fixed Overhead per month `1,08,000
Contribution per unit (` 200 - ` 120) `80
Hence the Break-even number of Units will be above 1,350 units

(1) Fixed Overhead in the first year `12,96,000
Contribution per unit (`200 – `120) `80
Hence the Break-even Number of Units to recover fixed cost will be above 16,200 units
` 12,96,000
—————
`80
But, at this Break -even Point another Fixed Cost will be incurred on Boxes.
Number of Boxed Required 324 units

Cost of Boxes (324 units × `400) `1,29,600
Now the Total Fixed Cost (`12,96,000 + `1,29,600) `14,25,000
Therefore the new Break-even point 17,820 units


CVP, Not for profit
Q18: Sound Well Music Society is a not-for- profit organization that brings guest artist to the
community’s greater metropolitan area. The music society just bought a small concert hall in
the centre of town to house its performances. The lease payments on the concert hall are
expected to be `40,000 per month.
The organization pays its guest performer `18,000 per concert and anticipates corresponding
ticket sales to be `45,000 per concert. The music society also incurs costs of approximately
`10,000 per concert for marketing and advertising. The organization pays its part-time artistic
director ` 3,30,000 per year and expects to receive `3,00,000 in donations in addition to its
ticket sales.
Required:
1. If the Sound Well Music Society just breaks even, how many concerts does it
hold?
2. In addition to the organization’s part-time artistic director, the music society
would like to hire a part-time marketing director for `2,55,000 per year. What is the
breakeven point? The music society anticipates that the addition of a marketing
director would allow the organization to increase the number of concerts to 41 per
year. What is the music society’s operating income/(loss) if it hires the new marketing
director?
3. The music society expects to receive a grant that would provide the
organization with an additional `1, 70,000 toward the payment of the marketing
director’s salary. What is the breakeven point if the music society hires the marketing
director and receives the grant?
Solution
1.
Ticket sales per concert `45,000
Variable costs per concert:
Guest performers `18,000
Marketing and advertising 10,000
Total variable costs per concert 28,000
Contribution margin per concert `17,000
Fixed costs
Salaries `3,30,000
Less payments (`40,000 x 12) `4,80,000
Total fixed costs `8,10,000
Less donations 3,00,000
Net fixed costs `5,10,000
Breakeven point in units = = = 30 concerts

Check
Donations `3,00,000
Revenue (`45,000 × 30) 13,50,000
Total revenue 16,50,000
Less variable costs
Guest performers (`8,000 × 30) `5,40,000
Marketing and advertising (`10,000 × 30) `3,00,000
Total variable costs 8,40,000
Less fixed costs
Salaries `3,30,000
Mortgage payments 4,80,000
Operating income `0
2.

Fixed costs
Salaries (`3,30,000 + `2,55,000) `5,85,000

Less payments (`40,000 × 12) 4,80,000

Check
Donations `3,00,000
Revenue (`45,000 × 30) 20,25,000
Less variable costs
Marketing and advertising (`10,000 × 30) 4,50,000
Less fixed costs
Salaries ` 5,85,000
Total fixed costs 10,65,000
Operating income `0
Operating income if 41 concerts are held
Donations `3,00,000
Revenue (`45,000 x 30) 18,45,000
Less variable costs
Guest performers (`18,000 x 41) `7,38,000
Marketing and advertising (`10,000 x 41) 4,10,000
Less fixed costs
Salaries `5,85,000
less payments 4,80,000
Operating income (loss) ` (68,000)
The Music Society would not be able to afford the new marketing director if the number of
concerts were to increase to only 41 events. The addition of the new marketing director
would require the Music Society to hold at least 45 concerts in order to breakeven. If only 41
concerts were held, the organization would lose `68,000 annually. The music society could
look for other contribution to support the new marketing director’s salary or perhaps increase
the number of attendees per concert if the number of concerts could not be increased beyond
41.

Fixed costs
Salaries (`3,30,000 + `2,55,000) `5,85,000
Less payments (`40,000 x 12) 4,80,000

Check
Donations `4,70,000
Revenue (`45,000 × 35) 15,75,000
Less variable costs
Marketing and advertising (`10,000 × 30) 3,50,000
Less fixed costs
Salaries `5,85,000
Operating income `0

Q24: The skilled labour force is employed under permanent contracts of
employment under which they must be paid for 40 hours per week’s labour,
even if their time is idle to absence of orders. Their rate to pay is $16 per hour,
although any overtime is paid at time and a half. In the next two weeks, there is
apare capacity of 150 labour hours.
There is no spare capacity for Semi-skilled workers. They are currently paid
$12 per hour or time and a half for overtime. However, a local agency can
provide additional semi-skilled workers for $14 per hour.
What cost should be included in the quotation for skilled labour and semi-
skilled labour?
Skilled Semi-skilled
A $3,600 $4,200
B $1,200 $4,200
C $3,600 $5,400
D $1,200 $5,400
Solution:- If the order require 300 hours

Skilled Labour:-
First 150 hours :- Nil
(Due to Permanent & Spare)
Next 150 hours:- (16+8) = 24
=150 X24 =3600
Semi Skilled:-
New to be appointed due to Low rate as compare to existing (12 +6) =18
New Rate = 14 X 300 = 4200.

Q25: Which of the following statements about relevant costing are true?
1. An opportunity cost will always be a relevant cost even if it is a past cost.
2. Fixed costs are always general in nature and are therefore never relevant.
3. Committed costs are never considered to be relevant costs.
4. An opportunity cost represents the cost of the best alternative forgone.
5. Notional costs are always relevant as they make the estimate more realistic.
6. Avoidable costs would be saved if an activity did not happen and so are relevant
7. Common costs are only relevant if the viability of the whole process is being
assessed
8. DIfferencial costs in a make or buy decision are not considered to be relevant.
A (2), (3), (4) and (6)
B (1), (2), (5) and (7)
C (3), (4), (6) and (7)
D (1), (5) (6) and (8)

Q26: XL Polymers, located in Sahibabad Industrial Area, manufactures high quality
industrial products.
AT Industries has asked XL Polymers for a special job that must be completed within one
week. Raw material R1 (highly toxic) will be needed to complete the AT Industries’ special
job. XL Polymers purchased the R1 two weeks ago for `7,500 for a job ‘A’ that recently was
completed. The R1 currently in stock is the excess from that job and XL Polymers had been
planning to dispose of it. XL Polymers estimates that it would cost them `1,250 to dispose of
the R1. Current replacement cost of R1 is `6,000.
Special job will require 250 hours of labour G1 and 100 hours of labour G2. XL Polymers
pays their G1 and G2 employees `630 and `336 respectively for 42 hours of work per week.
XL Polymers anticipates having excess capacity of 150 [G1] and 200 [G2] labour hours in
the coming week. XL Polymers can also hire additional G1 and G2 labour on an hourly basis;
these part-time employees are paid an hourly wage based on the wages paid to current
employees.
Suppose that material and labour comprise XL Polymers’s only costs for completing the
special job.
Required: CALCULATE the ‘Minimum Price’ that XL Polymers should bid on this job?
Solution
Opportunity Cost of Labour - The G2 labour has zero opportunity cost as there is no other use
for the time already paid for and is available. However, XL Polymers needs to pay an
additional amount for G1 labour. This amount can be save if the special job were not there.
G1 labour:
Hours Required 250
Hours Available 150
Extra Hours Needed 100
Cost per hour (`630/42hrs) `15
Opportunity Cost `1,500
Thus, the ‘Opportunity Cost of Labour’ for completing the special job is `1,500.
Opportunity Cost of Material – XL Polymers has no alternative use for the R1, they must
dispose of it at a cost of `1,250. Thus, XL Polymers actually saves `1,250 by using the
materials for the AT Industries’ special job. Consequently, the ‘Opportunity Cost of Material’
is - `1,250 (i.e., the opportunity cost of this resource is negative).
The minimum price is the price at which XL Polymers just recovers its ‘Opportunity Cost’.
XL Polymers’s ‘Total Opportunity Cost’ is `250 (`1,500 − `1,250). Accordingly, minimum
Price for the
Special Job is `250.

Q29: Buildico, a company that builds houses presents the following facts relating to a certain
housing 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.
1200 kgs of raw material Z will be required for the house. Inventory of Z available is 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 not in calculating the cost of the given housing project:
Sl. No. Item Type of Cost Relevant (R)/

Irrelevant (IR)
1. Food and hotel expenses ` 3,750
2. (i) Material Z; 550 kg × ` 580/kg
(ii) Material Z: 550 kg × ` 650 per kg
3. (i) Engineer’s salary ` 47,500
(ii) Engineer’s free time cost 60/150 × 47,500
4. (i) Design cost ` 30,000
(ii) Design cost ` 50,000
Answer:
Si. No. Item Type of Cost Reelvant/irrelevant
1 Food and hotel expenses `3,750 Sunck cost Irrelevant
2(i) Mateial Z. 550 kg X `580/kg Historical cost/Sunk Irrelevant

Cost
2(ii) Mateiral Z: 550 kg X ` 650 per kg Repalcement cost Relevant
3(i) Engineer’s Salary `47,500 Peirod cost Relevant
3(ii) Engineer’s Free time cost Committed Irrelevant

60/150 X ` 47,500 Cost/Unavoidable
cost
4(i) Design Cost ` 30,000 Sunk Cost Irrelevant

4(ii) Design Cost ` 50,000 Opportunity cost Relevant

Q31: 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:
Mateial A requried 5,000 Kg Avaialble in stock . I was purchased 5 years
ago at `35 per kg. if not used for M, it can be
sold as scrap @`15 per kg.
Mateial B required 8,000 kg This has to be purcjhased at `25 per kg from
the market.
Other Hardwar items 10,000 To be incurred
Dept X- Labour 5 men for 1 month @ Labour ro be freshly hired. No spare
oriented ` 7,000 per month per capacity available
man
Dept Y- Machine 3,000 machine hours Existing spare capacity may be used
oriented @ ` 5 per machine
hour
Pattern & Specification `15,000 To be incurred for M but after the Order, it
can be sold for `2,000.
Answer:
Particulars Computation `
Mateial A Already available-Rarely used-can be scrapped-NRV 75,000
Material B (i.e. Scrap value) lost is relevant as Opportunity cost 2,00,000

(5,000 kg × `15)
Other Hardware items To be purchased hence, out of pocket cost is relevant. 10,000
Department X (8000 kg × `25) 35,000
Department Y TO be purchased.hence out of pocket cost is relevant Nil
Pattern & Specification To be hired.Hence out of pocket cost is relevant (5 men 13,000
X 1 month × ` 7000)
Spare capacity to be used. Hence `5 per hour is

irrelevant (Note: `5 ph is assumed as Absorption rate
irrespective of actual usage.)
Net effective cost to be incurred is relevant, i.e. `15,000

- ` 2,000
Minimum Price =Total Reelvant cost as above 3,33,000

Q34:A Company manufacture a wide range of fashion fabric. The Company is
considering whether to add a further product “SUPERB” to the range. A market
researcher survey recently undertaken at a Cost of ` 1,00,000 suggest that demand for
the superb will last for only year during which 50,000 unit could be sold at ` 1000/- per
unit the following information is available regarding the cost of Manufacture “Superb”.
Raw Material: Each product required Four types of Raw Material M1, M2, M3, M4.
@M1:- For every unit of Superb 1 Kg of M1 is required at present material M1 is not available
in stock. Current Resale value of M1, = 2/- Kg. & Current Replacement cost of M1 = ` 2/- Kg.
M2:- Each unit of Superb require 2 unit of M2. The Current stock of M2 = 1,50,000 unit lying
in Go down has no other use. The current Resale value = ` 2.00 or it can be used in place of
another material R2, current replacement cost of R2 = ` 3.00 P.U.)]
Current Replacement cost of M2 = 4.00 Per unit.
M3:- Material M3 is also in stock but it is unlikely that any additional supply can be obtained
for some considerable time due to of an industrial dispute, at present time material. M3 can be
used in producing a product Z which has SP = 450 Per unit. & total Variable Cost (Excluding
or material M3) is 100 Per unit & 1 unit of Z require 5 unit of M3. Each unit of Superb require
1 unit of M3. Current stock available = 2,00,000 units of M3
Current resale value of M3 = 20/- Per unit.
Current Replacement value of M3 = not applicable.
Original cost of M3 = ` 10/- per unit.
M4:- Current stock = 20,000 unit
Each unit of Superb require one unit of M4, if superb could not be produced that material of
M4 need to be disposed at a cost to the Co. of ` 2/- Per unit.
Current Replacement cost = 5/- Per unit.
LABOUR: Each products require 2 hour of skilled(grade I), 3 hours unskilled & 4 hours of
Semi skilled labour, Skilled labour (Grade I) rate ` 1 per hour & Skilled labour (Grade I) is
employed on casual basis.
Unskilled labour is under utilized & company’s policy is to continue to pay unskilled labour
(not to retrenched) current wage rate = 2/- per hour.
Semi skilled labour is presently engaged in meeting the demand for product “L” which
required 4 hour of semi skilled labour. The contribution from sale of 1 unit of “L” = 24/-
current wage rate of semi skilled = 2/- per hour.
Supervisory Labour cost = ` 2,00,000
Supervisory staff will remain whether or not the contract is accepted.
Each product of Superb would require 5 hours of highly skilled labour (Grade II). An
employee possessing in necessary skills is available is currently paid ` 5 per hour. A
replacement would however to be obtained at rate of 4/- per hour for the work, which would
other, wise to be done by Highly skilled employee. (Grade II).
FOREMAN LABOUR COST: 2,40,000.
MACHINERY: Two machines would be required to manufacture “Superb” MT 4 and MT
7. Details of each machine are as under:
Start of the year End of the year

` `
MT 4: Replacement Cost 80,000 65,000
Resale Value 60,000 47,000
MT 7: Replacement Cost 13,000 9,000
Resale value 11,000 8,000
Straight-line depreciation has been charged on each machine for each year of its life. The
Company owns a number of MT 4 machines, which are used regularly on various products.
Each MT 4 is replaced as soon as it reaches the end of its usual life.
MT 7 machines are no longer used and the one which would be used for “Superb” is the only
one the company now has. If it was not used to produce “Superb”, it would be sold
immediately.
OVERHEADS: A predetermined rate of recovery for overhead is in operation and the fixed
overheads are recovered fully from the regular production at ` 3.50 per labour hour. Variable
overhead costs are estimated at ` 1.20 per unit produced. For the decision-making,
incremental costs based upon relevant cost and opportunity costs are usually computed.
Acceptance of the contract would be expected to encroach on the sale and production of
another product, Y that is also made by Co. It is estimated that sales of Y, would then
decreases by 5,000 units in the next year only. However this forecast reduction in sales of Y
would enable attributable fixed factory overheads of ` 58,000 to be avoided. Information on Y
is as follows:
Per Unit
Sales Price ` 70
Labour-Skilled (Grade-1) 4 Hours per unit
Materials –relevant costs ` 12
Variable Overhead 1.20
Required: Advise Co. on the desirability of the contract.
Solution:
Statement of cost benefit
` Lakhs
Revenue (50000 ×1000) 500
Loss – Relevant Cost
Materials WN-2 40.10
Labour WN-4 17.00
Highly Skilled Labour 10.00
Foreman 2.40
Machine – WN-7 0.18
Overhead (1.2 × 50000) 0.60
Opportunity Cost 2.06
Net Benefit 427.66
Decision-
Its better to accept the offer.
W.N.-1
Market Research cost `100000 to be consider or sunk cost due to past cost.
Working Note-2 `
Material M1-out of stock –CPP (50000 × 2) 100000
M2 1000000 Kg ×`3 300000
(obsolete/substitute)
Sale Sub. Offer

`2 or `3
Material –M3 WN-3 (70 × 50000 ×1) 3500000
M4 –out of stock 30000 × 5 150000
Benefit to be achieved (20000 × 2) (40000)
Total 4010000
W.N. -4 Labour
Skilled Labour `
Casual/not busy) 50000 unit × 2 Hrs × `1 Hour 10000
Unskilled (50000 unit × 3 Hrs × 2) Nil
Permanent & idle
Semi-Skilled Labour *50000 Unit ×4 hrs. × `8) 1600000
Casual/Busy/Short supply
Per Unit ` Per Hrs.

Revenue - XX Labour Cost -2
Material - XY + Contribution - 6 1700000
- Labour - 4× 2 To be Cost 8
Contribution – 24
4 Hr.
Contribution – per Hour `6/per Hours.
W. N. -3 For M3
M3
(Regular/Short supply)
Per Unit of Z
` Offer
Revenue -450 `70per unit of M3
V. Cost -100
(Other then M3) -
350
M3 –Original 5 Unit = 70/-
Past Cost
In this situation we should ignore the selling price because it’s not possible to sale for same
considerable time due to industrial dispute.
W.N.-5
Supervisory staff will continue to occur irrespective of offer hence called sunk cost.
W.N.6
Highly skilled Labour – Gr-4
Employee (Ram)
5/- per Hour present work

New Workers =4/-
Offer (shift) (Terminate)
If offer not accepted. Regular offer Total
(Ram) 5 Nil 5
If Offer accept (Shyam) 4 5/- (Ram) 9
4
4 Hrs × 5hr × 50000
= `1000000
W.N. -7 Machine
MT4 Regular use
`
Cost to be incurred 80000
-Transfer to Regular stock 6500
Difference of Rept-Cost 15000
MT-7 obsolete
Benefit to be cost 11000
Benefit to be achieved 8000
3000
Total Cost = 15000 + 3000 = `18000
WN-8
Rate = Bu –OH =3.5/Hours
B Hrs.
Benefit of 5000 Unit of Y will have to be lost due to acceptance of offer= Opportunity Cost
5000 Unit
Revenue @70 350000
-Mat - @12 6000
-Lab – 5000 × 4H ×1 20000
-VOH 5000 × 1.2 6000
-Avoidable FC 58000
Benefit 20600

Q45: ANZB Financial Services Limited is an Indian banking and financial services company
headquartered in Chennai, Tamil Nadu. Apart from lending to individuals, the company
grants loans to micro, small and medium business enterprises. Listed below are several costs
incurred in the loan division of ANZB Financial Services Limited.
Remuneration of the loan division manager.
(ii) Cost of Printer Paper, File Folders, View Binders, Ink, Toner & Ribbons used in the
loan division.
(iii) Cost of the division’s MacBook Pro purchased by the loan division manager last year.
(iv) Cost of advertising in business newspaper by the bank, which is allocated to the loan
division.
Cost Classification
I II III
Controllable by the loan division Direct cost of the loan division Sunk Cost
manager
Uncontrollable by the loan Indirect Cost of the loan division Out of Pocket Cost
division manager
Required
For each Cost, indicate which of the above mentioned Cost Classification best describe the
cost.
Solution:
Cost Incurred – Cost Classification
S. Cost Incurred Classification 1 Classification 2 Classification 3
No.
(i) Remuneration of the Uncontrollable by Direct cost of the Out of Pocket Cost
loan division the loan division loan division.
manager. manager.
(ii) Cost of Printer Paper, Controllable by the Direct cost of the Out of Pocket Cost
File Folders, View loan division loan division.
Binders, Ink, Toner & manager.
Ribbons used in the
loan division.
(iii) Cost of the division’s Controllable by the Direct cost of the Sunk Cost
MacBook Pro loan division loan division.
purchased by the loan manager.
division manager last
year.
(iv) Cost of advertising in Uncontrollable by Indirect Cost of Out of Pocket
business newspaper the loan division the loan division. Cost
by the bank, which is manager.
allocated to the loan
division.

Relevant Cost Concept
Q50: Golden Pacific Airlines Ltd. operates its services under the brand ‘Golden Pacific’. The
‘Golden Pacific’ route network spans prominent business metropolis as well as key leisure
destinations across the Indian subcontinent. ‘Golden Pacific’, a low-fare carrier launched
with the objective of commoditizing air travel, offers airline seats at marginal premium to
train fares across India.
Profits of the ‘Golden Pacific’ have been decreasing for several years. In an effort to improve
the company’s performance, consideration is being given to dropping several flights that
appear to be unprofitable.
Income statement for one such flight from ‘New Delhi’ to ‘Leh’ (GP - 022) is given below
(per flight):
` `
Ticket Revenue 7,35,000
(175 seats × 60% Occupancy × ` 7,000 ticket price)
Less: Variable Expenses (`1,400 per person) 1,47,000
Contribution Margin 5,88,000
` `
Less: Flight Expenses:
Salaries, Flight Crew 1,70,000
Salaries, Flight Assistants 31,500
Baggage Loading and Flight Preparation 63,000
Overnight Costs for Flight Crew and Assistants at 12,600
destination
Fuel for Aircraft 2,38,000
Depreciation on Aircraft 49,000*
Liability Insurance 1,47,000
Flight Promotion 28,000
Hanger Parking Fee for Aircraft at destination 7,000 7,46,100
Net Gain/(Loss) (1,58,100)
* Based on obsolescence
The following additional information is available about flight GP-022.
1. Members of the flight crew are paid fixed annual salaries, whereas the flight assistants
are paid by the flight.
2. The baggage loading and flight preparation expense is an allocation of ground crew’s
salaries and depreciation of ground equipment.
3. One third of the liability insurance is a special charge assessed against flight GP-022
because in the opinion of insurance company, the destination of the flight is in a “high-risk”
area.
4. The hanger parking fee is a standard fee charged for aircraft at all airports.
5. If flight GP-022 is dropped, ‘Golden Pacific’ Airlines has no authorization at present
to replace it with another flight.
Required
Using the data available, prepare an ANALYSIS showing what impact dropping flight GP-
022 would have on the airline’s profit.
Answer: As per the statement given in the problem, Flight GP-022 incurs a net (loss) of `
158,100. This is the net result of revenue less costs. Revenue is entirely variable depending
upon passenger occupancy. Costs are both variable and fixed nature. To analyze the impact of
dropping flight GP-022, we need to re-compute net gain/(loss) that Golden Pacific earns
when it operates the flight based on relevant costing principles.
Net Gain/(Loss)
= Revenue earned from flight operations less Variable costs of operation
Revenue earned is the ticket revenue earned from flight operations of GP-022, this is entirely
variable. Variable costs of flight operations are those expenses that would be incurred only
when the flight is operated. These include variable expenses per passenger, salaries flight
assistants, overnight costs for flight crew and assistants, fuel for aircraft, a third portion of
flight insurance that is specifically related to this flight sector and flight promotion expense.
These are expenses that will not be incurred if the flight is not operated. Hence, relevant for
decision making.
Other expenses like salaries of flight crew and hanger parking fees for aircraft are fixed
expenses that will be incurred even if the flight does not operate. Loading and flight
preparation expense is an allocated cost that will continue to be incurred even if flight GP-
022 does not operate. Depreciation of aircraft and liability insurance expense (2/3 rd portion
not related to a specific flight sector) are sunk costs. These expenses have already been
incurred and hence are irrelevant to decision making. Therefore, these fixed, allocated and
sunk expenses are ignored while analyzing the decision whether to continue operating flight
GP-022.
Flight GP-022
Statement Showing Net Gain/(Loss)
` `
Contribution Margin if the flight is continued 5,88,000
Less: Flight Costs
Flight Promotion 28,000
Fuel for Aircraft 2,38,000
Liability Insurance (1/3 × `1,47,000) 49,000
Salaries, Flight Assistants 31,500
Overnight Costs for Flight Crew and Assistants 12,600 3,59,100
Net Gain/(Loss) 2,28,900
If Golden Pacific Airlines Ltd. discontinues flight GP-022, profits will reduce by ` 2,28,900.
The statement showing loss in operations of ` 158,100 is misleading for decision making
purpose because it accounts for costs that are fixed and irrelevant. However, since flight GP-
022 yields a net gain of ` 2,28,900, flight operations should continue.

Keep or Drop Decision
Q53: Rabi Ltd. is considering the discontinuance of Division C. The following information is
given:
Particulars Divisions A & B Division C Total
Sales (Maximum achievable) 41,40,000 5,17,500 46,57,500
Less: Variable cost 20,70,000 2,76,000 23,46,000
Contribution 20,70,000 2,41,500 23,11,500
Less: Specific avoidable fixed cost 14,49,000 4,14,000 18,63,000
Divisional Income 6,21,000 (1,72,500) 4,48,500
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.
Required: COMMENT on the decision to discontinue Division C using relevant cost
approach.
Solution
As given in the problem Rabi Ltd. is considering to discontinue the Division C perhaps by
seeing the Division C‘s 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 `2,30,000 to Divisions A & B and Rabi Ltd. as a whole.
Let assess the decision of the Rabi Ltd. with the help of the Relevant Cost approach.
Particulars Amount (`)
Savings Due to Discontinuance
Specific Fixed Cost 4,14,000
Total ...(A) 4,14,000
Loss/Increase in Cost Due to Discontinuance
Loss of Contribution 2,41,500
` 20, 70, 000 × 10 2,30,000
Increase in Variable Cost
90
Total …(B) 4,71,500
Excess of Loss Over Savings …(B) – (A) 57,500
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.

Q57: Wye plc makes and sells four products. The profit and loss statement for April is as
follows:
W X Y Z Total
$ $ $ $ $
Sales 30,000 20,000 35,000 15,000 100,000
Cost of sales 16,000 8,000 22,000 10,000 56,000
Gross profit 14,000 12,000 13,000 5,000 44,000
Overhead cost 8,000 7,000 8,500 6,500 30,000
selling
Administration 2,000 2,000 2,000 2,000 8,000
Net profit 4,000 3,000 2,500 (3,500) 6,000
The management team is concerned about the results, particularly those of product Z. and it
has been suggested that Wyc plc would be better off if it ceased production of product Z. the
production manager has said that if product Z were discontinued the resources which would
become available could be used to increase production of product Y by 40 percent. You have
analysed the cost structures of each of the products and discovered the following:
W X Y Z Total
$ $ $ $ $
Variable costs 4,800 1,600 13,200 5,000 24,600
Fixed costs 11,200 6,400 8,800 5,000 31,400
Gross profit 16,000 8,000 22,000 10,000 56,000
The total fixed costs figure includes $20,000 which is not specific to any one product, and
which has been apportioned to ech product on the basis of sales values. If the quantity of any
product increases by more than 25 percent, then the specific fixed production costs of the
product will increase by 30 per cent.
The selling overhead comprises a fixed cost of $5,000 per product plus a variable cost which
varies in proportion to sales value. The fixed cost is not specific to any product but the sales
director belives that it should be shared equally by the four products.
The administration cost is fixed central overhead cost; it is not affected by the products made.
Required:
(a) Prepare a statement which shows clearly the results of continuing to produce products
W, X, Y and Z at the same volumes as were achieved in April. Present your statement
in format suitable for management decision-making.
(b) (i) prepare a statement showing clearly the results if product Z is discontinued, and
the number of units of Y is increased in accordance with the production manager’s
statement. (Assume that no change in selling price per unit is necessary to sell the
additional units.)
(ii) reconcile the profit calculated in (a) and (b)(i) above; advise the management team
as to whether product Z should be discontinued.
(c) Explain briefly any non-financial factors which should be considered before
discontinuing a product.
Solution:
(a) The profit statement needs to be restated in a marginal costing format if it is to be
useful for decision-making.
W X Y Z Total
$ $ $ $ $
Sales 30,000 20,000 35,000 15,000
Variable cost of sales 4,800 1,600 13,200 5,000
Variable selling overhead (*) 3,000 2,000 3,500 1,500
Contribution 22,200 16,400 18,300 8,500
Specific fixed costs (W1) 5,200 2,400 1,800 2,000
Net benefit 17,000 14,000 16,500 6,500 54,000
Non-specific fixed cost of sales 20,000
Fixed selling overhead (W2) (20,000)
Administration costs (8000)
Net profit 6,000
(*) Total overhead less $5,000 fixed cost.
Workings
W X Y Z Total
$ $ $ $ $
Fixed costs 11,200 6,400 8,800 5,000 31,400
Non-specific fixed costs (*) 6,000 4,000 7,000 3,000 20,000
Specific fixed costs 5,200 2,400 1,800 2,000 11,400
(*) given as $20,000 apportioned on the basis of sales value (3:2:3:5:1.5)

(b) (i) Z discontinued
$
Contribution from 40% additional sales of y ($18,300 x 0.4) 7,320
Additional specific fixed costs (540)
Loss of net benefit from Z (6,500)
Net gain 280
(ii) Profit reconciliation
Existing profit 6,000
Discontinuation of Z (6,500)
Additional contribution from Y 7,320
Additional specific fixed costs (540)
Profit if Z is discontinued and sales of Y substituted 6,280
(b) Non-financial factors to consider include:

(1) Possible redundancies among the workforce
(2) Signals which it may give to competitors, who may perceive the company as being
unwilling to support its products
The reaction of customers, particularly those who may recently have purchased the product.

Q58: It is possible that some costs are avoided in the longer term but not in the short term.
For instance, it may be necessary to give notice to cease renting a space occupied by a
department. If the notice required is, say three months then the rental is an unavoidable cost
until the three months’ notice has expired. After that time has becomes an avoidable cost, as
long as notice is given now.
The idea of cost is being unavoidable in the short term adds a new dimension to our decision-
making. Not only it is necessary to decide whether costs are inherently avoidable, but we may
also need to determine when they will become avoidable.
In the very short term almost all costs are unavoidable. In the long term almost all costs are
avoidable because the whole organization could be shut down completely. Here we are
talking about time horizons in between these two extremes.
The following exercise will give you some practice at identifying the costs which are relevant
to a decision to close a department: the avoidable costs. It will also demonstrate how to
decide on the correct timing for a decision.
A company is considering the closure of its internal printing department. The department
prints all of the company’s publicity material and it also carries out other printing jobs are
required.
An external firm has offered to produce all of the company’s printing requirements for a total
cost of £9,000 per month. The internal printing department’s costs are as follows:
(a) A total of 80,000 sheets of customized paper are used each month, at a cost of £50 per
1,000 sheets. The contract for supply of the paper requires three months’ notice of
cancellation. The company does not hold inventory of the paper but any excess can be
sold for a net price of £20 per 1,000 sheets.
(b) A total of 400 litres of fluorescent ink are used each month, at a cost of £1.80 per litre.
The contract for supply of this ink requires 1 month’s notice of cancellation. No
inventory of ink is held but any excess can be sold for £0.50 net per litre.
(c) Other paper and materials costs amount to £2,850 per month.
(d) The printing machinery is rented for £4,500 per month. It is operated for 120 hours
each month. The rental contract can be cancelled with 2 months notice.
(e) The two employees in the department are each paid £1,000 per month. The company
has a no- redundancy policy which means that the employees are guaranteed
employment even if the department closes.
(f) Overhead cost for the printing department is as follows:
(i) Variable overhead: £4 per machine hour
(ii) Fixed overhead: £3 per machine hour
Variable overhead varies in direct proportion to the machine hours operated. Fixed overhead
represents an appointment of central overheads which would not alter as a result of the
printing department’s closure.
Requirement: Calculate the long-term monthly saving or extra cost which will result from
the closure of the printing department. If you consider that the department should be closed,
you are asked to advice on the most appropriate timing for its closure.
Solution:
The long term monthly saving or cost can be calculated by identifying the relevant costs,
ignoring the effect of the notice required on certain of the contracts.
The labour cost and the fixed overheads are not relevant. They would be incurred even if the
department is closed.
Relevant cost of internal printing
£ per month
Customized paper 80 × £50 4,000
Fluorescent ink 400 × £1.80 720
Other paper and material 2,850
Machine rental 4,500
Variable overhead £4 × 120 480
Total relevant cost of internal printing 12,550
Cost of external printing services 9,000
Monthly saving from closure 3,550
Therefore the offer from the external supplier should be accepted, resulting in a monthly
saving of £3,550.
This saving would only be made in the long term’, once all of the relevant notice period have
expired. In the immediate short term, some cost would still be incurred because of the need to
give notice of cancellation. It is possible to demonstrate the effect of this by charting in which
month each saving will be made. In the following table, ‘month 1’ is taken to mean ‘one
month from now’.
Relevant saving and revenues
Month 1 Month 2 Month 3 Month 4
£ £ £ £
Customized paper (note 1) - - - 4,000
Revenue of sales of excess paper 1,600 1,600 1,600 -
Fluorescent ink (note 2) - 720 720 720
Revenue of sales of excess ink 200 - - -
Other paper and materials (note 3) 2,850 2,850 2,850 2,850
Machine rental (note 4) - - 4,500 4,500
Variable overhead (note 3) 480 480 480 480
Relevant savings and revenues 5,130 5,650 10,150 12,550
External cost 9,000 9,000 9,000 9,000
Saving/(excess cost) from closure 3,870 3,350 1,150 3,350
Note that the monthly saving settles down as the ‘long-term’ amount of £3,550 once all of the
notice periods have expired.
Notes:
1. The saving on customized paper will not be made until month 4, because 3 month’s
notice is required and the company is obliged to purchase the paper. However, if
printing is ceased immediately the paper could be re-sold for £1,600 per month.
2. The saving on fluorescent ink will not be made until month 2 because the company
will be obliged to purchase it for the first month. If printing is ceased immediately the
ink could be re-sold for £200 for 1 month.
3. The other material costs and the variable overheads are relevant from month 1,
because they can be avoided as soon as the department closes.
4. The machine rental will only be saved from month 3 onwards, because it must be paid
for anyway for the next 2 months.
Recommendation
The printing department should be closed in month 3 and £1,150 will be saved in that month.
From month 4 onwards the monthly saving will amount to £3,550. In the mean time, notice
should be given on the relevant contracts as follows:
Customized paper: Give immediate notice. Continue to use the paper for 2 months, then
resell the supplies in month 3 when the department is closed.
Fluorescent ink: Give notice at the end of month 1. The notice will then expire at the
beginning of month 3 when the department is closed.
Printing machinery: Give immediate notice. The notice will then expire at the beginning of
month 3 when the department is closed.

Q59: PMS plc is a large diversified organization with several departments. It is concerned
over the performance of one of its departments – department P. PMS plc is concerned that
department P has not been able to meet its sales target in recent years and is considering
either to reduce the level of production or to shut down the department.
The following information has been made available:
Budgeted sales and production in units 50,000
000
500
Sales
Less production costs
Material A – 1 kg per unit 50
Material B – 1 litre per unit 25
Labour – 1 hour per unit 125
Variable overhead 100
Non-production costs 50
Fixed Overhead 50
Total costs 400
Budgeted profit 100
The following additional information has also been made available:
(i) There are 50,000 kg of material A in inventory. The original cost £1 per kg. material
A has no other use and unless it is used by the division it will have to be disposed at a
cost of £500 for every 5,000 kg
(ii) There are 30,000 litres of material B in inventory. Any unused material can be used
by another department to substitute for an equivalent amount of a material, which
currently costs £1.25 per litre. The original cost of material B was £0.50 per litre and
it can be replaced at a cost of £1.50 per litre.
(iii) All production labour hours are paid on an hourly basis. Rumours of the closure of the
department have led to a large proportion of the department’s employees leaving the
organizations. Uncertainty over its closure has also resulted in management not
replacing these employees. The department is therefore short of labour hours and has
sufficient to produce 25,000 units. Output in excess of 25,000 units would require the
department to hire contract labour at accost of £3.75 per hour. If the department is
shut down the present labour force will be deployed within the organization.
(iv) Included in the variable overhead is the depreciation of the only machine used in the
department. The original cost of the machine was £200,000 and it is estimated to have
a life of 10 years. Depreciation is calculated on a straight-line basis. The machine has
a current resale value of £25,000. If the machinery is used for production it is
estimated that the resale value of the machinery will fall at the rate of £100 per 1,000
units produced. All other costs included in variable overhead vary with the number of
units produced.
(v) Included in the fixed production overhead is the salary of the manager of department
P which amount to £20,000. If the department were to shut down the manger would
be made redundant with a redundancy pay of £25,000. All other costs included in the
fixed production overhead are general factory overheads and will not be affected by
any decision concerning department P.
(vi) The non production cost charged to department P is an apportioned of the total non-
production costs incurred by the department.
(vii) The marketing manager suggest that either:
 A sale volume of 25,000 units can be achieved with a selling price of £9.000 per unit
and an advertising campaign of £25,000; or
 A sales volume of 35,000 units can be achieved at a selling price of £7.50 with an
advertising campaign costing £35,000.
Requirements: As the management accountant of PMC plc you have been asked to
investigate the following options available to the organization:
(i) Reduce production to 25,000 units
(ii) Reduce production to 35,000 units
(iii) Shut down department P.
Solution:
Relevant savings 25,000 units 35,000 units Shut down
And revenue £ £ £
Sales revenues 225,000 262,500 -
Material B 6,250 - 37,500
Sales of machinery 22,500 21,500 25,000
Total revenue/savings 235,750 284,000 62,500
Relevant costs
Material A disposal 2,500 1,500 5,000
Purchase material B - 7,500 -
Labour 62,500 100,000 -
Variable overhead 40,000 56,000 -
(excl. depreciation)
Advertising campaign 25,000 35,000 -
Manager’s salary 20,000 20,000 -
Redundancy pay - - 25,000
Total relevant costs 150,000 220,000 30,000
Net savings 103,750 64,000 32,500

Make or Buy decision
Q61: A company manufacture two models of a pocket calculator. The basic model sells for
£5, has a direct material cost of £1.25 and require 0.25 hours of labour time to produce. The
other model, the Scientist, sells for £7.50, has a direct material cost of £1.63 and takes 0.375
to produce. Labour, which is paid at the rate of £6 per hour, is currently very scarce, while
demand for the company’s calculator is heavy. The company is currently producing 8,000 of
the basic model and 4,000 of the Scientist model per month, while fixed costs are £24,000 per
month.
An overseas customer has offered the company a contract, worth £35,000 for a number of
calculators made to its requirements. The estimating department has ascertained the following
facts in the respect of the work:
 The labour time for the contract would be 1,200 hours.
 The material cost would be £9,000 plus the cost of a particular component not
normally used in the company’s models.
 These components could be purchased from a supplier for £2,500 or alternatively,
they could be made internally for a material cost of £1,000 and an additional labour
time of 150 hours.
Requirement: Advice the management as to the action they should taske.
Solution:
In view of its scarcity labour is taken as the limiting factor.
The decision on whether to make or buy component has to be made before it can be decided
whether or not to accept the contract. In order to do this the contribution per labour hour for
normal production first be calculated, as the contract will replace some normal production.
Normal products Basic Scientist
£ £ £ £
Selling price 5.00 7.50
Materials 1.25 1.63
labour 1.50 2.25
2.75 3.88
Contribution 2.25 3.62
Contribution per direct labour hour (@ 0.25/0.375 9.00 9.65

hrs/unit)
Therefore if the company is to make the component it would be better to reduce production of
the basic model, in order to accommodate the special order.
The company should now compare the cost of making or buying the component.
An opportunity cost arises due to the lost contribution on the basic model.
Special contract Manufacture of component
Materials 1,000
Labour (£6 × 150 hours) 900
Opportunity cost (150 hours × £9.00) 1,350
3,250
Since this is higher than the bought-in price of £2,500 the company would be advised to buy
the component from the supplier if they accept the contract.
The contract can now be evaluated:
Contract contribution
£ £
Sales revenue 35,000

Contract contribution
£ £
Material cost 9,000
Component 2,500
Labour (£6 x 1,200) 7,200
18,700
Contribution 16,300
Contribution per direct labour hour £13.58
Since the contribution is higher than either of the existing products, the company should
accept assuming this would not prejudice the market for existing products. As the customer is
overseas this seems a reasonable assumption.
Because the contribution is higher for the Scientist model it would be wise to reduce
production of the basic model. However, the hours spent on producing the basic model per
month are 8,000 units × 0.25 hours = 2,000, and so the contract would displace more than a
fortnight’s production of the basic model. The recommendation assumes that this can be done
without harming long-term sales of the basic model.

Q64: Aditya Ltd. manufactures four products A-1, B-2, C-3 and D-4 in Gurgaon and one
product F-1 in Faridabad. Aditya Ltd. operates under Just-in-time (JIT) principle and does not
hold any inventory of either finished goods or raw materials.
Company has entered into an agreement with M Ltd. to supply 10,000 units per month of
each product produced from Gurgaon unit at a contracted price. Aditya Ltd. is bound to
supply these contracted units to M Ltd. without any fail. Following are the details related
with non contracted units of Gurgaon unit.
(Amount in `)
A-1 B-2 C-3 D-4
Selling Price per unit 360.00 285.00 290.00 210.00
Direct Labour @ ` 45 per hour 112.50 67.50 135.00 67.50
Direct Material M-1 @ ` 50 per kg. 50.00 100.00 --- 75.00
Direct Material M-2 @ ` 30 per litre. 90.00 45.00 60.00 ---
Variable Overhead (varies with labour hrs) 12.50 7.50 15.00 7.50
Variable Overhead (varies with machine hrs) 9.00 12.00 9.00 15.00
Total Variable Cost 274.00 232.00 219.00 165.00
Machine Hours per unit 3 hours 4 hours 3 hours 5 hours
Maximum Demand per month (units) 90,000 95,000 80,000 75,000
The products manufactured in Gurgaon unit use direct material M-1 and M-2 but product F-1
produced in Faridabad unit is made by a distinct raw material Z. Material Z is purchased from
the outside market at ` 200.00 per unit. One unit of F-1 requires one unit of material Z.
Material Z can also be manufactured at Gurgaon unit but for this 2 hours of direct labour, 3
hours of machine time and 2.5 litres of material M-2 will be required.
The Purchase manager has reported to the production manager that material M-1 and M-2 are
in short supply in the market and only 6,50,000 Kg. of M-1 and 6,00,000 litre of M-2 can be
purchased in a month.
Required:
(i) CALCULATE whether Aditya Ltd. should manufacture material Z in Gurgoan unit or
continue to purchase it from the market and manufacture it in Faridabad unit.
(ii) CALCULATE the optimum monthly usage of Gurgaon unit’s available resources and
make decision accordingly.
(iii) CALCULATE the purchase price of material Z at which your decision in (i) can be
sustained.
Solution
(i) Manufacturing Cost of Material Z, if Manufactured in Gurgaon unit
Amount (`)
Direct Labour (2 hours × `45) 90.00
Direct Material M-2 (2.5 litre × `30) 75.00
Variable Overhead, Varies with Labour Hours (2hours × `5) 10.00
Variable Overhead, Varies with Machine Hours (3hours × `3) 9.00
Total Variable Cost 184.00
The purchasing cost of material Z from the outside market is `200, which is more than the
cost to manufacture it in Gurgaon unit. Hence, it will be beneficial for the Aditya Ltd. to
manufacture material Z in Gurgaon unit itself.
(ii) Monthly Requirement of Direct Material M-1 & M-2
For Contracted units
A-1 B-2 C-3 D-4 Total
Units to be Supplied to M Ltd. (units) 10,000 10,000 10,000 10,000 40,000
Direct Material M-1 (in Kg) [W.N.-1] 10,000 20,000 --- 15,000 45,000
Direct Material M-2 (in Litre) [W.N.-2] 30,000 15,000 20,000 --- 65,000
For Non-Contracted units
A-1 B-2 C-3 D-4 Total
Demand in Outside Market (units) 90,000 95,000 80,000 75,000 3,40,000
Direct Material M-1 (in Kg) [W.N.-1] 90,000 1,90,000 --- 1,12,500 3,92,500
Direct Material M-2 (in Litre) [W.N.- 2,70,000 1,42,500 1,60,000 --- 5,72,500
2]
Availability and Demand Comparison
Direct Material M-1 Direct Material M-2
(in Kg) (in Litre)
Availability in Market 6,50,000 6,00,000
Requirement 4,37,500 6,37,500
(45,000+3,92,500) (65,000+5,72,500)
Material M-2 is a limiting factor as its availability is less than its requirement to produce
contracted as well as for non-contracted units.
To optimum usage of resources available in Gurgaon unit, prioritization of production of
products is necessary. The following is the comparison table of product A-1, B-2, C-3 and Z.
Product D-4 is not taken into comparison as material M-2 is not required to produce product
D-4.
Calculation of Contribution per litre of M-2
A-1 B-2 C-3 Z
Contribution per unit (W.N-3 & 4) ` 86.00 ` 53.00 ` 71.00 ` 16.00
Quantity of Material M-2 per unit 3 litre 1.5 litre 2 litre 2.5 litre
Contribution per litre of M-2 ` 28.67 ` 35.33 ` 35.50 ` 6.40
Rank III II I IV
Since, contribution per unit of material Z is lowest as compared to other products consuming
material M-2. Material –Z cannot be manufactured under the given resource constraint.
Hence only existing products of Gurgaon units should be manufactured.
Optimum Production Plan
Product No. of Units Quantity of M-2 Required Balance Availability of M-2
(in Litre) (in Litre)
C-3 90,000 1,80,000 4,20,000
(90,000 units × 2 litre) (6,00,000 – 1,80,000)
B-2 1,05,000 1,57,500 2,62,500
(1,05,000 units × 1.5 litre) (4,20,000 – 1,57,500)
A-1 87,500* 2,62,500 0
(87,500 units × 3 litre) (2,62,500 – 2,62,500)
(*) Units that can be produced with the help of available quantity of M-2 i.e. 2,62,500 litre.
(iii) Decision in requirement (i) will be changed as material Z cannot be manufactured in
Gurgaon unit as noted in requirement (ii). The minimum purchase price of material Z at
which decision taken in (i) above can be sustained is calculated as below:
Working Notes
(1) Quantity of M-1 required per unit of production
A-1 B-2 D-4
Cost per unit `50 `100 `75
Rate per Kg. `50 `50 `50
Quantity per unit of Production 1Kg. 2Kg. 1.5Kg.
(2) Quantity of M-2 required per unit of production
A-1 B-2 C-3
Cost of per unit `90 `45 `60
Rate per Kg. `30 `30 `30
Quantity per unit of Production 3 litre 1.5 litre 2 litre
(3) Contribution per unit (`)
A-1 B-2 C-3 D-4
Selling Price per unit 360 285 290 210
Less: Variable Cost per unit 274 232 219 165
Contribution per unit 86 53 71 45
(4) Contribution (Benefit) per unit of Material Z
(`)
Purchasing Cost per unit 200
Less: Cost of Manufacture 184
Contribution per unit 16
(5) The next best product to material Z is A-1 {as calculated in (ii) above} which has a
contribution of `28.67 per litre of M-2 which is `22.27 (`28.67 – `6.40) higher than the
contribution per litre of M-2 for material Z. Material Z required 2.5 litre of M-2, therefore,
purchase price of material Z would have to `55.68 (2.5 litre × `22.27) higher than the existing
market price.

Q65: Robber Co. manufactures control panel for burglar alarm, a very profitable product.
Every product comes with a one year warranty offering free repairs if any faults arise in this
period.
If currently produces and sells 80,000 units per annum, with production of them being
restricted by the short supply of labour. Each control panel includes two main components-
one key pad and one display screen. At present Robert Co manufactures both of these
components in-house. However, the company is currently considering outsourcing the
production of keypads and/or display screens. A newly established company based in
Burgistan is keen to secure a place in the market, and has offered to supply the keypads for
the equivalent of $4.10 per unit and the display screens for the equivalent of $4.30 per unit.
This price has been guaranteed for two years.
The current total annual cost of producing the keypads and the display screens are:
Keypads Display screens
Production 80,000 units 80,000 units
$000 $000
Direct materials 160 116
Direct labour 40 60
Heat and power costs 64 88
Machine costs 26 30
Depreciation and insurance costs 84 96
Total annual production costs 374 390
Materials cost for keypads are expected to increase by 5% in six months’ time; materials
costs for display screens are only expected to increase by 2%, but with immediate effect.
Direct labour costs are purely variable and not expected to change over the next year.
Heat and labour costs include an appointment of the general factory overhead for heat and
power as well as the cost of heat and power directly used for the production of keypads and
display screens. The general apportionment included is calculated using 50% of the direct
labour cost for each component are manufactured in-house or not.
Machine costs are semi-variable; the variable element relates to set up costs, which are based
upon the number of batches made. The keypad s’ machine has fixed costs of $4,000 per
annum and the display screens’ machine has fixed costs of $6,000 per annum. Whilst both
components are currently made in batches of 500, this would need to change, with immediate
effect, to batches of 400.
60% of depreciation and insurance costs relate to an apportionment of the general factory
depreciation and insurance costs; the remaining 40% is specific to the manufacture of
keypads and display screens.
Required:
(a) Advice Robber Co whether it should continue to manufacture the keypads and display
screens in-house or whether it should outsource their manufacture to the supplier in
Burgistan, assuming it continues to adopt a policy to limit manufacture and sales to
80,000 control panels in the coming year.
(b) Robber Co takes 0.5 labour hours to produce a keypad and 0.75 labour hours to
produce a display screen. Labour hours are restricted to 100,000 hours and labour is
paid at $1 per hour. Robber Co wishes to increase its supply top 100,000 control
panels (i.e. 100,000 each of keypads and display screens).
Advice Robber Co as to how many units of keypads and display panels they should either
manufacture and/or outsource in order to minimize their costs.
Discuss the non-financial factors that Robber Co should consider when making a decision
about outsourcing the manufacture of keypads and display screens.
Solution
Make or buy decision
(all working amounts in $000) Keypads Display screens
Variable costs $ $
164,000
Materials ($160 × ) + ($160 x 1.05 × )
($116 x 1.02) 118,320
Direct labour 40,000 60,000
Machine set-up costs
($26 - $4) x 500 ÷ 400 27,500
($30 - $6) x 500 ÷ 400 30,000
231,500 208,320
Attributable fixed costs
Heat and power ($64 - $20) ÷ ($88 - $30) 44,000 58,000
Fixed machine costs 4,000 6,000
Depreciation and insurance ($84/$96 x 40%) 33,600 38,4000
81,600 102,400
Total incremental costs of making in-house 313,100 310,720
Cost of buying (80,000 x $4.10/$4.30) 328,800 344,000
Total saving from making 14,900 33,280
Robber should therefore make all of the keypads and display screens in-house.
Tutorial note: It is assumed that the fixed set-up costs only arise if production takes place.
Alternative method
Relevant costs Keypads Display screens
Direct materials $ $
164,000
( ) +( )
$116,000 x 1.02 118,320
Direct labour 40,000 60,000
Heat and power
$64,000 – (50% × $40,000) 44,000
$88,000 – (50% × $60,000) 58,000
Machine set up costs
Relevant costs Keypads Display screens
Direct materials $ $
Avoidable fixed costs 4,000 6,000
Activity related costs (W) 27,500 30,000
Avoidable depreciation and insurance costs:
40% x $84,000/$96,000 33,600 38,400
Total relevant manufacturing costs 313,1000 310,720
Relevant cost per unit: 3.91375 3.884
Cost per unit of buying in 4.1 4.3
Incremental cost of buying in 0.18625 0.416
As each of the components is cheaper to make in-house than to buy in, the company should
continue to manufacture keypads and display screens in-house.
Working
Current no. of batches produced = 80,000 ÷500 = 160
New no. of batches produced = 80,000 ÷400 = 200
Current cost per batch for keypads = ($26,000 - $4,000) ÷ 160 = $137.5
Therefore new activity related batch cost = 200 x $137.5 = $27,500
Current cost per batch for display screens = ($30,000 - $6,000) ÷ 160 = $150
Therefore new activity related batch cost = 200 x $150 = $30,000
(b) make or buy – higher production level
The attributable fixed costs remain unaltered irrespective of the level of production of
keypads and display screens, because as soon as one unit of either is made, the costs rise. We
know that we will make at least one unit of each component as both are cheaper to make
them buy. Therefore they are an irrelevant common cost.
Keypads Display screens

$ $
Buy 4.1 4.3
Variable cost of making ($231,500 ÷80,000) 2.89
($208,320 ÷ 80,000) 2.6
Saving from making per unit 1.21 1.7
Labour hour per unit 0.5 0.75
Saving from making per unit of limiting factor 2.42 2.27
Priority of making 1 2
Total labour hours available = 100,000
Make maximum keypads (i.e. 100,000) using 50,000 labour hours (100,000 X 0.5 hours)
Make 50,000 ÷0.75 display screens (i.e. 66,666 display screens).
Therefore buy in 33,334 display screens (100,000 – 66,666).
Non-financial factors
 The company offering to supply the keypads and display screens is a new company.
This would make it extremely risky to rely on it for continuity of supplies. Many new
businesses fail within the first year of starting and without these two crucial
components, Robber would be unable to meet demand for sales to control panels.
Robber would need to consider whether there are any other potential suppliers of the
components. This would be useful both as a price comparison now and also to
establish the level of dependency that would be committed to if this new supplier is
used. If the supplier were to go out of business, would any other company be able to
step in? if so, at what cost?
 The supplier has only agreed to these prices for the first two years. After this, it could
put up its prices dramatically. By this stage, Robber would probably be unable to
begin easily making its components in house again, as it would probably have sold
off its machinery and committed to larger sales of control panels.
 The quality of the components could not be guaranteed. If they turn out to be poor
quality, this will give rise to problems in the control panels, leading to future loss of
sales and high repair costs under warranties for Robber. The fact that the supplier is
based overseas increases the risk of quality and continuity of supply, since it has even
less control of these than it would if it was a UK supplier.
Robber would need to establish the supplier is with meeting promises for delivery times. This
kind of information may be difficult to establish because of the fact that the supplier is a new
company. Late delivery could have a serious impact on robber’s production and delivery
schedule.

Make or buy with ABC
Q66: The Bharti Televenture manufactures cellular modems. It manufactures its own cellular
modern circuit boards (CMCB), an important part of the cellular modem. It reports the
following cost information about the costs of making CMCBs in 2006 and the expected costs
in 2007:
Current costs in Expected costs
2006 in 2007
Variable manufacturing costs
Direct material cost per CMCB `1,800 `1,700
Direct manufacturing labour cost per CMCB 500 450
Variable manufacturing cost per batch for setups, 16,000 15,000

material handling, and quality control
Fixed manufacturing cost
Fixed manufacturing overhead costs that can be 32,00,000 32,00,000

avoided if CMCBs are not made
Current costs in Expected costs
2006 in 2007
Fixed manufacturing overhead costs of plant 80,00,000 80,00,000

depreciation, insurance, and administration that
cannot be avoided even if CMCBs are not made
Bharti manufactured 8,000 CMCBs in 2006 in 40 batches of 200 each. In 2007, Bharti
anticipates a requirement of 10,000 CMCBs. The CMCBs would be needed in 80 batches of
125 each.
The Reliance Infocom has approached Bharti about supplying CMCBs to Bharti in 2007 at
`3,000 per CMCB on whatever delivery schedule Bharti wants.
Required: Calculate the total expected manufacturing cost per unit of making CMCBs in
2007.
Suppose the capacity currently used to make CMCBs will become idle if Bharti purchases
CMCBs from Reliance. On the basis of financial considerations alone, should Bharti make
CMCBs or buy them from Relaince? Show your calculations.
Now suppose that if Bharti purchases CMCBs from Reliance, its best alternative use of the
capacity currently used for CMCBs is to make and sell special circuit boards (CB3s) to the
Airtel Corporation. Bharti estimates the following incremental revenues and costs from
CB3s:
Total expected incremental future revenues `2,00,00,000
Total expected incremental future costs `2,15,00,000
On the basis of financial considerations alone, should Bharti make CMCBs or buy them from
Reliance?
Show your calculations.
Solution
Make versus buy, activity based costing
The expected manufacturing cost per unit of CMCBs in 2007 is as follows:
Total manufacturing Manufacturing cost

costs of CMCB per unit
(1) (2)= (1) ÷10,000
Direct materials `1,700 × 10,000 `1,70,00,000 `1,700
Direct manufacturing labour `450 × 10,000 45,00,000 450
Variable batch manufacturing cost `15,000 × 12,00,000 120

80
Fixed manufacturing costs
Avoidable fixed manufacturing costs 32,00,000 320

Unavoidable fixed manufacturing costs 80,00,000 800
Total manufacturing costs `3,39,00,000 `3,390
The following table identifies the incremental costs in 2007 if Bharti (a) made CMCBs and
(b) purchased CMCBs from Reliance.
Total incremental costs Per-unit incremental

costs
Incremental items Make Buy Make Buy
Cost of purchasing CMCbs from `3,00,00,000 `3,000

Reliance
Direct materials `1,70,00,000 `1,700
Direct manufacturing labour 45,00,000 450
Variable batch manufacturing cost 12,00,000 120
Avoidable fixed manufacturing costs 32,00,000 320
Total incremental costs `2,59,00,000 `3,00,00,000 `2,590 `3,000
Reference in favor of making `41,00,000 `410
That the opportunity cost of using capacity to make CMCBs is zero since Bharti would
keep this capacity idle if it purchases CMCBs from Reliance

Key factors Decision
Q70: Lucky Ltd manufactures and sells three products, X,Y and Z for which budgeted sales
demand, unit selling prices and unit variable costs are as follows.
Budgeted Sales X Y Z
demand 550 units 500 units 400 units
$ $ $ $ $ $
Unit sales Price 16 18 14
Variable Costs: Materials 8 6 2
Labour 4 6 9
12 12 11
Unit contribution 4 6 3
The company has existing stocks of 250 units of X and 200 units of Z, which it is quite
willing to use up to meet sales demand.
All three products use the same direct materials and the same type of direct labour . in the
next year, the available supply of materials will be restricted to $4,800(at cost) and the
available supply of labour to $6,600 (at cost).
Required:
Determine what product mix and sales mix would maximize the company’s profit in the next
year.
Solution:
There appear to be two scare resources, direct materials and direct labour. This is not certain,
however, and because there is a limited sales demand as well, either of the following might
apply.
There is no limiting factor at all, except sales demand.
There is only one scarce resource that prevents the full potential sales demand being
achieved.
Step 1: Establish which of the resources, f any, is scare.
X Y Z
Units Units Units
Budgeted Sales 550 500 400
Stock in hand 250 0 200
Minimum production to meet demand 300 500 200
Minimum Required materials Required labour at

production to meet at cost cost
sales demand Units $ $
X 300 2.400 1,200
Y 500 3,000 3,000
Z 200 400 1,800
Total required 5,800 6,000
Total available 4,800 6,600
(Shortfall)/Surplus (1,000) 600
Materials are a limiting factor, but labour is not.

Step 2. Rank X, Y and Z in order of contribution earned per $1 of direct materials
consumed.
X Y Z
$ $ $
Unit Contribution 4 6 3
Cost of materials 8 6 2
Contribution per $1 materials $0.50 $1.00 $1.50
Ranking 3rd 2nd 1st
Step 3: Determine a production plan Z should be manufactured up to the limit where units
produced plus units in stock will meet sales demand, then Y second and X third, until all the
available material are used up.
Ranking Product Sales Production Material cost

demand less Quantity
$
units in
units
stock Units
1st Z 200 200 (X $2) 400
2nd Y 500 500 (x $6) 3,000
3rd X 300 175 (x$8) 1,400
Total available 4,800
Step 4. Draw up a budget. The profit maximizing budget is as follows.
X Y Z
Units Units Units
Opening stock 250 0 200
Add production 175 500 200
Sales 425 500 400
X Y Z Total
$ $ $ $
Revenue 6,800 9,000 5,600 21,400
Variable costs 5,100 6,000 4,400 15,500
Contribution 1,700 3,000 1,200 5,900

Q76: Jaya-Surya Ltd. (JSL) manufactures and sells two products ‘Jaya’ and ‘Surya’. Both
Jaya and Surya use a regular machine while Surya uses another high-precision machine as
well. The following information is available for the next quarter.
Jaya Surya
Selling Price per unit (`) 1,500 2,000
Variable Manufacturing Cost per unit (`) 900 1,600
Variable Marketing Cost per unit (`) 250 150
Budgeted Allocation of Fixed Overhead Costs (`) 18,00,000 85,00,000
Regular Machine Hours per unit 2.0 1.0
Further information is available as follows:
JSL faces a capacity constraint of 60,000 hours on the regular machine for the next quarter
and there is no constraint on the high precision machine for the next quarter.
Out of ` 85,00,000 budgeted allocation of fixed overhead costs to product Surya, ` 60,00,000
is payable for hiring the high precision machine. This cost is charged entirely to product
Surya. The hiring agreement can be cancelled at any time without penalties.
All other overhead costs are fixed and cannot be changed.
A minimum quantity of 12,500 units per quarter of Jaya must be produced to fulfill a
commitment to a customer.
Any quantity of any product can be sold at the given prices.
Required:
(i) Calculate the product mix of Jaya and Surya which would maximise the relevant
operating profit of JSL in the next quarter.
(ii) JSL can double the quarterly capacity of regular machine at a cost of
` 28,00,000. Calculate the new product mix and the amount by which the relevant
operating profit will increase.
Solution:
Calculation of Contribution Margin per machine hour
Jaya Surya
(`) (`)
Selling Price per unit 1,500 2,000
Less: Variable Manufacturing Cost per unit (900) (1,600)
Less: Variable Marketing Cost per unit (250) (150)
Contribution Margin per unit 350 250
Number of Regular Machine Hours 2.0 1.0
Contribution Margin per machine hour 175 250
Ranking II I
Based on the ranking above, manufacturing preference will be given to Surya but after the
committed production of 12,500 units of Jaya.
Since to manufacture Surya, a hiring cost of ` 60,00,000 is also paid for high precision
machine, so the result obtained through the above ranking may not be beneficial. For this
purpose we solve this problem taking two options.
Option 1: 12,500 units of Jaya and 35,000* units of Surya:
*[60,000 hours – (12,500 units of Jaya × 2 hours) ÷ 1 hour to produce one unit of Surya]
Amount (`)
Contribution Margin on Jaya (12,500 units × ` 350) 43,75,000
Contribution Margin on Surya (35,000 units × ` 250) 87,50,000
Total Contribution Margin 1,31,25,000

Less: Hire Charges on High Precision Machine (60,00,000)
Net Relevant Contribution 71,25,000
Option 2: Produce only Jaya i.e. 30,000 units:

Contribution Margin/Net Relevant Contribution (30,000 units × ` 350)
= ` 1,05,00,000
Even though Surya has the higher contribution margin per machine hour but net relevant
contribution option 1 is lower than the option 2. Hence, JSL should produce 30,000 units of
Jaya only to earn more profit.
(ii) Based on the above ranking, if preference is given to production of Surya after the
production of committed units of Jaya i.e. 12,500 units of Jaya and 95,000 units of Surya.
Option 1: 12,500 units of Jaya and 95,000* units of Surya:
*[1,20,000 hours – (12,500 units of Jaya × 2 hours) ÷ 1 hour to produce one unit of Surya]
Amount (`)
Contribution Margin on Jaya (12,500 units × ` 350) 43,75,000
Contribution Margin on Surya (95,000 units × ` 250) 2,37,50,000
Total Contribution Margin 2,81,25,000
Less: Hire Charges on High Precision Machine (60,00,000)
Less: Capacity Enhancement Cost (28,00,000)
Net Relevant Contribution 1,93,25,000
Option 2: Produce only Jaya i.e. 60,000 units:
Amount (`)
Contribution Margin (60,000 units × ` 350) 2,10,00,000
Less: Capacity Enhancement Cost (28,00,000)
Net Relevant Contribution 1,82,00,000
When capacity of the regular machine is doubled, the optimum product mix will be 12,500
units of Jaya and 95,000 units of Surya.
Increase in operating profit will be ` 88,25,000 ` 1,93,25,000 – ` 1,05,00,000).
While calculating relevant contribution from the option 1 and option 2 in requirements (i) and
(ii) above, the contribution from the 12,500 units of Jaya may also be ignored as this is same
under the two options.

Q78: DFG manufactures two products from different combination of the same resources.
Unit selling prices and cost details for each product are as follows:
Product D G
£/unit £/unit
Selling price 115 120

7Direct material A (£5 per kg) 20 10
Direct material B (£3 per kg) 12 24
Skilled labour (£7 per hour) 28 21
Variable overhead (£2 per machine hour) 14 18
Fixed overhead* 28 36
Profit 13 11
*fixed overhead is absorbed using an absorption rate per machine hour. It is an unavoidable
central overhead cost that is not affected by the mix or volume of products produced.
The maximum weekly demand for product D and G is 400 units and 450 units respectively
and this is the normal weekly production volume achieved by DFG. However, for the next
four weeks the achievable product level will be reduced due to a shortage of available
resources. The resources that are expected to be available as follows:
Direct material A 1,800 kg
Direct material B 3,500 kg
Skilled labour 2,500 hours
Machine time 6,500 machine hours
Required:
(a) Using graphical linear programming identify the weekly production scheduled for
products D and G that maximizes the profits of DFG during the next four weeks.
(b) Explain the relevance of these values to the management of DFG.
Note: assume that demand is not affected by the selling price. You are not required to
perform any calculation.
Solution
Step 1 Define variables
Let D be the number of product D produced
Let g be the number of product G produced
Step 2 Resources required by each product
D G
Direct material A
= 2kg
Direct material B
= 8 kg
Skilled labour
Machine time
Step 3 Establish objective function

The objective function should be to maximize contribution rather than profit, as fixed
overheads are not affected by the mix or volume of products produced.
D G
$ $
Selling price 115 120
Total variable costs 74 73
Contribution per unit 41 47
The objective function to be maximized is:
Contribution = 41D + 47G
Step 4 Establish constraints
Use the per unit resources required that were calculated in step 2.
Direct Material A: 4D + 2G ≤ 1,800
Direct Material B: 4D + 8G ≤ 3,500
Skilled Labour: 4D + 3G ≤ 2,500
Machine Time: 7D + 9G ≤ 6,500
Product d demand: D ≤ 400
Product G demand: G ≤ 450
Non-negativity: D ≥ 0; G ≥ 0
D = 400
G
900 4D+2G = 1,800 units
800
700 4D+3G=2,500
600
500 Optimal point G = 450
400
300 Feasible point 7d +9G= 6,500
200 4d + 8G = 3,500
100
0 100 200 300 400 500 600 700 800 900
ISO-CONTRIBUTION LINES 41D+47G
The optimal point is reached at the intersection between:
4D + 2G = 1,800 (1)
4D + 8G = 3,500 (2)
Deduct equation (1) from equation (2)
6G = 1,700
G = 283
Substitute G = 283 into equation (1)
4D + (2 x 283) = 1,800
4D + 566 = 1,800
4D = 1,234
D=
D = 309
Therefore, profit is maximized when 309 units of D and 283 units of g are produced
contribution would be $25,970.
(b) Shadow price
The shadow price of a resource which is limiting factor on production is the amount by
which total contribution would fall if the organization was deprived of one unit of that
resource. Alternatively, it is the amount by which total contribution would rise if an extra
unit of that resource became available.
Skilled labour: Shadow price = £0
This indicates that skilled labour, although a limiting factor, is not a binding constraint on
production, given the current status of the other resources. Contribution would not be
affected if skilled labour was increased or reduced by one hour.
Direct Material A: Shadow price = £5.82
If direct material A was increased by one kg, contribution would increase by £5.82.
Similarly if supply of this material was reduced by one kg , contribution would fall by
£5.82. Direct material A is a binding constraint on production as the shadow price is
greater than zero.
(c) Selling price sensitivity analysis
The sensitivity of the optimal solution to changes in the selling price of product D can be
determined by changing the slope of the iso-contribution line. As the selling price of
product D increased, the slope of the iso-contribution line would become steeper. The
optimal solution will change when the slope of the iso- contribution line is such that its
last point in the feasible region is no longer 309 units of product d and 283 units of
product G.

Q79: W/plc provides two cleaning services for staff uniform to hotels and similar businesses.
One of laundry service and the other is a dry cleaning service. Both of the services use the
same resource different quantities. Details of the expected resource requirements, revenues
and costs of each are given below.
Laundry Dry clean
$ per service $ per service
Selling price 7.00 12.00
Cleaning material ($10.00 per litre) 2.00 3.00

Direct labour ($6.00 per hour) 1.20 2.00
Variable machine cost ($3.00 per hour) 0.50 1.50
Fixed costs* 1.15 2.25
profit 2.15 3.25
*The fixed costs per service were based on meeting the budget demand for December 20 × 3.
W plc has already prepared its budget for December based on sales and operational activities
services and 10,500 dry cleaning services, but it is now revising its plans because of forecast.
The maximum resources expected to be available in December 20X3 are
Cleaning materials 5,000 litres
Direct labour hours 6,000 hours
Machine hours 5,000 hours

W plc has one particular contract which is entered into six months ago with a local hotel to
guide laundry services and 2,000 dry cleaning services every month, if W plc does not
honour this can pay substantial financial penalties to the local hotel.
Required:
(a) Calculate the mix of services that should be provided by W plc so as to maximize its
pro 20 × 3.
(b) The sales director has reviewed the selling prices being used by W plc and has
provided further information.
(1) If the price for laundry were to be reduced to $5.60 per service, this would
increase 14,000 services.
(2) If the price for dry cleaning were to be increased to $13.20 per service, this would
demand to 9,975 services.
Required: Assuming that such selling price changes would apply to all sales and that the
resources limitations continue to apply, and that a graphical linear programming solution is to
be used to maximize profit:
(i) State the constraints and objective function.
(ii) Use a graphical programming solution to advice W plc whether it should revise its
selling prices.
Solution
Step 1 Cleaning materials
Litres
1,600
Required laundary ( )
3,150
Dry cleaning ( )
Available 4,750
Spare 5,000
250
Therefore, not scarce
Direct labour hours
Hours
1,600
3,500
Dry cleaning ( )
Available 5.100
Spare 6,000
900
Therefore not scares
Machine hours
Hours
1,333.3
5,250.0
Dry cleaning ( )
Available 6,583.3
Spare 5,000.0
1,583.3
Therefore, scares
Step 2 Rank the services in terms of contribution per hour of machine time
Laundry Dry cleaning
Unit contribution
$(2.15 + 1.15)
$(3.25 + 2.25) $3.30
Machine hours per service
($0.5/$3)
($1.5/$3)
Contribution per hour of machine time $19.80

ranking 1
Step 3 Determine a production plan
Demand Machine hours required
Contracted services
Laundry 200
1,200 (× )
Dry cleaning 1,000
2,000 (× )
Non-contracted services
Laundry
6,800* (× ) 1,133
Dry cleaning
5,333**(× ) 2,666
*8,000 – 1,2000
**2,666 ÷
Profit-maximising mix of services
Laundry: 8,000 services
Dry cleaning: 7,333 services
(b) (i) define variables
Let l = number of laundry services provided
Let d = number of dry cleaning services provided
Establish objective function
Fixed costs will be the same irrespective of the optimal mix and so the objective contribution
(c).
Laundry: revised contribution = $5.60 - $(2 + 1.2 + 0.5) = $1.90
Dry cleaning: revised contribution = $13.20 - $(3 + 2 +_1.5) = $6.70
Maximize c = 1.91 + 6.7d, subject to the constraints below.
Establish constraints
Cleaning materials:
Direct labour:
Variable machine cost:
Maximum and minimum services (for contract): 14,000 ≥ l ≥ 1,200

9,975 ≥ d ≥ 2,000
(ii) Establish coordinates to plot lines representing the inequalities
Cleaning materials: if l = 0, d = 16,667
If d = 0, l = 25,000
Direct labour: if l = 0, d = 18,000
If d = 0, l = 30,000
Variable machine cost: if l = 0, d = 10,000
If d = 0, l = 30,000
Also plot the lines l = 1,200 and d = 2,000, and l = 14,000 and d = 9,975
Construct an iso-contributional line
C = 1.9l + 6.7d
If c = (1.9 x 6.7 x 1,000) = 12,730
Then: If l = 6,700, d = 0
If d = 1,900, l = 0
Draw the graph (graph to show profit- maximizing mix of services)
D ‘000 services
Minimum I maximum I
20
Direct labour
Cleaning material
10 maximum
d
Variable machine
Feasible region
Maximum d
Iso contribution line
0 10 20
30 ‘000 services
Find the optimal solution
By moving the iso-contribution line out across the graph, it is clear that the optimal solution
lies at the intersection of lines representing the constraints for minimum number of laundry
services and machine hours.
Therefore, optimal solution occurs when:
L = 1,200 and + = 5,000

If l = 1,200, then d = (5,000 - 200) × 2 = 9,600
The optimal solution is to carry out 1,200 laundry services and 9,600 dry cleaning services.
Check the validity of revising selling prices
Maximum profit per mix in (a)
Contribution
Laundry: 8,000 x unit contribution of $3.30 26,400.0
Dry cleaning: 7,333 x unit contribution of $5.50 40,331.5
66,731.5
Less: fixed costs {(8,000 × $1.15) + (10,500 × (32,825.00)

$2.25)}
$
33,906.50
Maximum profit based on revised selling prices

$
Contribution
Laundry: 1,200 × unit contribution of $1.90 2,280
Dry cleaning: 9,600 × unit contribution of $6.70 64,320
66,600
Less: fixed costs {(8,000 × $1.15) + (10,500 × $2.25)} 32,825
33,775
By revising the selling prices, maximum profit achievable falls by $(33,906.5 – 33,775) =
$131.50
Therefore, in theory, prices should not be revised but the difference is so small that managers
should check carefully the reasonableness of the estimates used.

Q80: A company manufactures two products. Each product passes through two departments
A and B before it becomes a finished product. The data for the year are as under:
Product X Product Y
Maximum Sales Potential (in units) 7,400 10,000
Product unit data:

Selling Price p.u. `90 `80
Machine hrs. p.u.
Department A hrs. @ `40/hr. 0.50 0.30
Department B hrs. @ `60/hr. 0.40 0.45
Maximum Capacity of Department A is 3,400 hrs. and Department B is 3,640 hrs.

Maximum Quantity of Direct Materials available is 17,000 kgs. Each product requires 2 kg.
of Direct Materials. The Purchase Price of direct materials is ` 5/kg.
Required:
(i) FIND optimum product mix.
(ii) In view of the aforesaid production capacity constraints, the company has decided to
produce only one of the two products during the year. Which of the two products
should be produced and sold in the year to maximise profit? State the number of units
of that product and relevant contribution. Using Linear programming approach to
solve above problem.
Solution
(i) Calculation of Optimum Production Mix
Statement Showing Limiting Factor
Particulars Material Hours in Department A Hours in Department B
Required: X 14,800 kg. 3,700 hrs. 2,960 hrs.
Required: Y 20,000 kg. 3,000 hrs. 4,500 hrs.
Total Requirement 34,800 kg. 6,700 hrs. 7,460 hrs.
Available Resources 17,000 kg. 3,400 hrs. 3,640 hrs.
Shortage 17,800 kg. 3,300 hrs. 3,820 hrs.
Hence all the three resources are limiting factors.
Statement of Rank
Particulars Product X Product Y
Sales 90 80
Less: Direct Material 10 10
Dept. A 20 12
Dept. B 24 27
Contribution p.u. 36 31
Contribution per kg. of Raw Material 18 15.5
Rank I II
Contribution/hr. of Dept. A 72 103.33
Rank II I
Contribution/hr. of Dept. B 90 68.89
Rank I II
To find the optimum mix of products that shall lead to maximum profits while taking into
consideration of shortage of resources (i.e. constraints), we have to use Linear
Programming.
Let x1 and x2 donate quantities of product ‘x’ and product ‘y’ respectively.
The linear programming model for the given problem is:
Zmax = 36x1 + 31x2
Subject to:
2x1 + 2x2 ≤ 17 …(for material)
0.5x1 + 0.3x2 ≤ 3 …(for dept. A)
0.4x1 + 0.45x2 ≤ 3 …(for dept. B)
x1 ≤ 7 …(demand constraint)
x2 ≤ 10 …(demand constraint)
The graphical solution for the problem is given below:
So, different combination of product mix include,

Combination x1 x2 Total Contribution Rank
(in `)
P 6,800 0 2,44,800 IV
Q* 4,171 4,381 2,85,967 -
R 0 8,089 2,50,759 III
S 3,700 4,800 2,82,000 II
T 4,250 4,250 2,84,750 I
Note (*)
Combination Q (4,171, 4,381) is not possible as it is satisfying three conditions out of above
four conditions. To produce combination Q (4,171, 4,381), requirement of the material will
be 17,104 Kgs. (2 Kg × 4,171 units + 2 Kg × 4,381 units). However, material is available
17,000 Kgs. Accordingly, this combination is not possible.
Therefore, optimum product mix = X 4,250 units and Y 4,250 units.
(b) Statement Showing Product with Higher Contribution
Maximum Maximum Maximum Maximum Feasible Contribution
Demand Production by Production Production with Maximum
(a) Dept. A by Dept. B available Production (`)
(b) (c) materials (lower of a, b,
(d) c and d)
X 7,400 6,800 9,100 8,500 6,800 2,44,800

Y 10,000 11,333 8,089 8,500 8,089 2,50,759
Therefore, Product Y should be produced at 8,089 units resulting in a contribution of
`2,50,759.

Q81: The managers of Albion Co are reviewing the operations of the company with a view to
making operational decisions for the next month. Details of some of the products
manufactured by the company are given below.
Product AR2 GL3 HT4 XY5
Selling price ($/unit) 21.00 28.50 27.30
Material R2 (kg/unit) 2.0 3.0 3.0
Material R3 (kg/unit) 2.0 2.2 1.6 3.0
Direct labour (hours/unit) 0.6 1.2 1.5 1.7
Variable production overheads ($/unit) 1.10 1.30 1.10 1.40
Fixed production overhead ($/unit) 1.50 1.60 1.70 1.40
Expected demand for next (units) 950 1,000 900
Products AR2, GL3 and HT4 are sold to customers of Albion, while Product XY5 is a
component that is used in the manufacture of other products. Albion manufactures a wide
range of products in addition to those detailed above.
Material R2, which is not used in any other of Albion’s products, is expected to be in short
supply in the next month because of industrial action at a major producer of the material.
Albion has just received a delivery of 5,500 kg of Materials R2 and this is expected to be the
amount held in Inventory at the start of the next month. The company does not expect to be
able to obtain further supplies of material R2 unless it pays a premium price. The normal
market price is $2.50 per kg.
Material R3 is available at a price of $2.00 per kg and Albion does not expect any problems
in securing supplies of this material. Direct labour is paid at a rate of $4.00 per hour.
Folam Co has recently approached Albion with an offer to supply a substitute for product
XY5 at a price of $10.20 per unit. Albion would need to pay an annual fee of $50,000 for the
right to use this patented substitute.
Required:
(a) Determine the optimum production schedule for product AR2, GL3 and HT4 for the
next month, on the assumption that additional supplies of Material R2 are not
purchased.
(b) If Albion Co decides to purchase further supplies of Material R2 to meet demand for
Products AR2, GL3 and HT4, calculate the maximum price per kg that the company
should pay.
(c) Discuss whether Albion Co should manufacture Product XY5 or buy the substitute
offered by Folam Co. your answer must be supported by appropriate calculations.
Solution
Optimum production schedule
The optimum production schedule is found using limiting factor analysis.
Per unit: AR2 GL3 HT4
$ $ $
Material R2 2.5 x 2 = 5.00 2.5 x 3 = 7.50 2.5 x 3 = 7.50
Material R3 2 x 2 = 4.00 2 x 2.2 = 4.40 2 x 1.6 = 3.20
Labour 4 x 0.6 = 2.40 4 x 1.2 = 4.80 4 x 1.5 = 6.00
Variable overhead 1.10 130 1.10
Variable costs 12.50 18.00 17.80
Selling price 21.00 28.50 27.30
Contribution 8.50 10.50 9.50
Material R2 (kg/unit) 2 3 3
Contribution ($/kg of 8.5 ÷2 = 4.25 10.5 ÷3 = 3.50 9.5 ÷3 = 3.17
R2)
Ranking 1 2 3
Product Demand units R2 used kg Production Contribution $

units
AR2 950 1,900 950 8,075
GL3 1,000 3,000 1,000 10,500
HT4 900 600 200 1,900
5,500 20,475
The optimum production schedule is 950 units of product AR2, 1,000 units of GL3 and 200
units of HT4, giving a total contribution of $20,475. The fixed production overheads are
ignored in this analysis because they are assumed not to vary with changes in the level of
production.
(B) Further supplies of Material R2 will be used to p roduce additional units of
product HT4. The contribution per kg of Material R2 of product HT4 is $3.17and so if
Albion pays 3.17 + 2.50 per kg for Material R2, the additional units of Product HT4
produced will make a zero contribution towards fixed costs. $5.67 is therefore the
maximum price.
(C) The variable cost of Product XY5:
$/unit
Material R3: 3 x 2 = 6.00
Labour: 1.7 x 4 = 6.80
Variable overhead: 1.40
14.20
The substitute offered by Folam gives a saving of $4 per unit. However, Albion plc would
also pay an annual fee of $50,000 for the right to use the substitute. The company would need
to manufacture more than 50,000/4 = 12,500 units per year of Product XY5, or 1,042 units
per month, in order for the offered substitute to be financially acceptable. If it needed less
than 12,500 units of Product XY5 per year, it would be cheaper to manufacture the product in
house. This evaluation is from a short-term perspective: in the longer term, buying in may
lead to fixed cost savings and lower investment, increasing the benefits of buying in and
lowering the break-even point.
Albion plc would also need to assure itself that the quality of the substitute was acceptable
and that this quality could be maintained: the lower price offered by Folam might be
associated with poorer quality than that deemed necessary by Albion plc. Orders for the
substitute product would also need to be delivered promptly in order to avoid production
hold-ups.
Albion plc could also become dependent on Folam Limited for supplies of the substitute
product and might be vulnerable to future price increases by the supplier. Such price
increases might reduce or even eliminate the cost saving of buying in.

Outsourcing Part-II
Q84: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 figures are given to
you:
A B C D
Material cost (`/u) 32 36 44 20
Machine cost (`/u) @ ` 8 per hour) 48 32 64 24
Other variable costs (`/u) 64 72 45 56
Selling price (`/u) 162 156 178 118
Market demand (units) 52000 48,500 26,500 30,000
Fixed overheads at different levels of operation are:
Level of operation Total fixed Cost
(in production hours) (`)
upto 1,50,000 10,00,000
1,50,001-3,00,000 10,50,000
3,00,001-4,50,000 11,00,000
4,50,001-6,00,000 11,50,000
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:
A B C D
Sub-contract Price (`/u) 146 126 155 108
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 you suggestion.
Solution
Demand (Units)
52,000 48,500 26,500 30,000
A B C D
Selling Price 162 156 173 118
Direct Material 64 72 45 56
Manufacturing Cost 48 32 64 24
Other Variable Cost 32 36 44 20
Contribution (`/u) 18 16 20 18
Machine Hours per unit 6 4 8 3
Contribution (`/M/c hr.) 3 4 2.5 6
Ranking III II IV I
Sub-Contract Cost `/u) 146 126 155 108
Contribution (`/u) on (Sub-Contract) 16 30 18 10
Decision
It is more profitable to sub-contract B, since contribution is higher sub-contract.
1st Level of Operations
Produce D as much as possible = 30,000 units
Hours Required = 90,000 hrs (30,000 units X 3 hrs.)
Balance Hours Available = 60,000 hrs
Produce the Next Best
= 10,000 units of A
*Since B is better to be outsourced.
Product Particulars Contribut Contribution
ion/unit (`)
Produce: 10,000 units 18 1,80,000
A Outsource: 42,000 units 16 6,72,000
B Outsource Fully: 48,500 units 30 14,55,000
C Outsource Fully: 26,500 units 18 4,77,000
D Fully Produce: 30,000 units 18 5,40,000
Total Contribution 33,24,000
Less: Fixed Cost 10,00,000
Net Gain 23,24,000
2nd 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 `50,000 (25,000 units × `2) [Difference in Contribution sub-
contract and own manufacturing is ` 2]
But increase in Fixed Cost by `50,000.
At the 2nd level of operation, the increase in contribution by own manufacturing is exactly
set up by increase in fixed costs by ` 50,000/-. It is a point of financial indifference, but
otherconditions like reliability or possibility of the sub-contractor increasing his price may
beconsidered and decision may them but towards own manufacture.
3rd Level of Operation
Additional Hrs Available = 1,50,000 hrs.
Unit of A that are Needed = [52,000 – 25,000 (2nd Level) – 10,000
(1st Level)]
= 17,000 units
Hrs. Required for A 17,000 units × 6 hrs/u
1,02,000 hrs
Balance Hours Available for C 1,50,000 hrs – 1,02,000 hrs
48,000 hrs
Units of C can be Produced 6,000 units
Increase in Contribution over Level 1st or 2nd `46,000
(A: 17,000 units × `2 + C: 6,000 units × `2)
Increase in Fixed Cost 50,000
Additional Loss `50,000 - `46,000
`4,000
4th Level of Operation
Additional Hrs Available 1,50,000 hrs
Additional 1,50,000 can give 18,750 units of C
Increase in Contribution `37,500

(C: 18,750 units × 2)
Increase in Fixed Cost 50,000
Additional Loss `50,000 - `37,500
= 12,500
Level 1st Profit will go down by = `12,500 +`4,000
= `16,500
Advice
Do not Expand Capacities.
Summary
Product Produce Sub- Contribution Contribution Total
(Units) Contract (Production) (Sub-Contract) Contribution
(Units)
A 10,000 42,000 1,80,000 6,72,000 8,52,000
B — 48,500 — 14,55,000 14,55,000
C — 26,500 — 4,77,000 4,77,000
D 30,000 — 5,40,000 — 5,40,000
Total Contribution 33,24,000
Less: Fixed Cost 10,00,000
Profit 23,24,000


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6 Decision Making

Description Current Proposed Change

Selling Price (`/unit) 10

Direct Costs (`/unit) 5

Present number of setups per production period, 42

Break-even Sales (`) =

Break-even Sales (units) =

Total Fixed Overheads 108 1,296 110 1,320

Profit 108 1,296 106 1,272

Hence the Break-even number of Units will be above 1,350 units

Number of Boxed Required 324 units

Therefore the new Break-even point 17,820 units

Ticket sales per concert `45,000

Variable costs per concert:

Guest performers `18,000

Marketing and advertising 10,000

Total variable costs per concert 28,000

Contribution margin per concert `17,000

Less payments (`40,000 x 12) `4,80,000

Total fixed costs `8,10,000

Less donations 3,00,000

Net fixed costs `5,10,000

Breakeven point in units = = = 30 concerts

Ticket sales per concert `45,000

Salaries (`3,30,000 + `2,55,000) `5,85,000

Breakeven point in units = = = 45 concerts

Total variable costs per concert 28,000

Salaries (`3,30,000 + `2,55,000) `5,85,000

Less payments (`40,000 x 12) 4,80,000

Total fixed costs `10,65,000

Less donations 4,70,000

Net fixed costs `5,95,000

Breakeven point in units = = = 35 concerts

Revenue (`45,000 × 35) 15,75,000

Total revenue 20,45,000

Less variable costs

Guest performers (`18,000 × 35) `6,30,000

Marketing and advertising (`10,000 × 30) 3,50,000

Total variable costs 9,80,000

Less fixed costs

Mortgage payments 4,80,000

Total fixed costs 10,65,000

Solution:- If the order require 300 hours

Hours Required 250

Hours Available 150

Extra Hours Needed 100

Cost per hour (`630/42hrs) `15

Opportunity Cost `1,500

Sl. No. Item Type of Cost Relevant (R)/

1. Food and hotel expenses ` 3,750

2. (i) Material Z; 550 kg × ` 580/kg

(ii) Material Z: 550 kg × ` 650 per kg

3. (i) Engineer’s salary ` 47,500

(ii) Engineer’s free time cost 60/150 × 47,500

4. (i) Design cost ` 30,000

(ii) Design cost ` 50,000

Si. No. Item Type of Cost Reelvant/irrelevant

1 Food and hotel expenses `3,750 Sunck cost Irrelevant

2(i) Mateial Z. 550 kg X `580/kg Historical cost/Sunk Irrelevant

2(ii) Mateiral Z: 550 kg X ` 650 per kg Repalcement cost Relevant