Management &

Financial Accounting

Assessment-2

Model
Solution

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Question#1: State whether the following statements are true or false with explanation.

(a) The most likely to be a fixed cost for the manufacturing of a car will be Factory Rent
while costs related to Tyres, Contract Labour Wages and Electricity Costs will be
variable cost.

Answer: True: Factory rent is treated as fixed cost for the manufacturing of a car. A fixed
cost is an unavoidable operating expense that does not change in total over the short
term, even if a business experiences variation in its level of activity. Hence, Factory rent is
considered as fixed cost. On the other hand, cost related to tyres, contract labour wages
and electricity cost are variable cost as they vary in direct proportion of level of
activity/output These are recurring cost that changes in value according to the rise and
fall of revenue and output.

(b) If a company is offering an ‘add-on’ gift free along with the main product which a
customer does not need, then the company is destroying the value of the customer.

Answer: False: Offering an ‘add-on’ gift free along with the main product which a
customer does not need, does not lead that the company is destroying the value of the
customer because giving something extra helps to face over competition. An add-on
refers to an ancillary item sold to a buyer of a main product or service. Depending on the
business, add-on may represent a source of significant revenues and profits to a company.
Add-on help generate increased Customer Lifetime Value (CLV), which is the net profit
contribution a customer makes to company over time.

(c) Rent paid on a rented property taken by a firm is an example of variable cost as it
changes every year as per the terms and conditions of the contract.

Answer. False: Rent paid on a rented property taken by a firm is not an example of
variable cost as variable costs are expenses that change directly and proportionally to the
changes in business activity level or volume. Variable cost are incurred when any activity
of production is undertaken where as there are certain cost which are still incurred even
if there is no production activity, which are termed as fixed cost and rent is of fixed nature
which has to be paid even if there is no production.

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Question#2: Mangal Murti Plastics Limited is currently using a traditional two-stage cost
allocation system. In the first stage, all factory-overheads are allocated to two production
departments, A and B, based on machine hours; while the second stage uses direct labour
hours for absorption of these overheads to individual products – Regular and Deluxe.

During September 2020, Mangal Murti Plastics Limited had a total factory overhead cost of
Rs. 10 lakhs. The number of machine-hours used in the Production Departments A and B were
40,000 and 1,60,000 respectively. The number of direct labour-hours in Production
Departments A and B were 20,000 and 10,000 respectively.

From the above information, as per the traditional overhead allocation system, the cost of

Activity Cost Activity Application Rate

Driver
Material Receipt and Movement 70,000 350
200 per receipt and
movement
Production Setup 6,00,000 75 8,000 per production
set up
Inspection and Quality Check 3,00,000 10 30,000 per inspection
and quality check
Shipment 30,000 150 200 per shipment
Deluxe is coming to be Rs. 275.00 and profit Rs. 50 per unit; while that of Regular, cost Rs.
210 and profit Rs. 15 per unit.

Do you believe that the traditional system of allocating factory overheads is providing the
management better and more reliable cost information about the products for better
decision making? If no, then find the cost per unit and thereby profit per unit for Deluxe as
well as for Regular by using some alternative and better system (Activity-Based Costing) of
allocating overheads using the given information and give your observations and comments
for the same.

Answer: Activity Based Application Rates

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Determination of Cost per unit:

Cost and Profit determination under ABC Technique

Particular Deluxe (2000) Regular (8000)

Sales 6,50,000 18,00,000
A
Direct Material Cost 2,00,000 4,00,000
Direct Labour Cost 1,50,000 4,80,000
Prime
Cost
Factory Overhead 3,60,000 6,40,000
Total Cost 7,10,000 15,20,000
B
Total Cost per 355 190
unit
Profit or Loss (A-B) (60,000) 2,80,000

Explantion: The cost of Deluxe product is under costed. The cost of deluxe product is Rs 275
per product as per tradinational method whereas as per activity based costing the deluxe
product cost is Rs 355 per product. Hence, the deluxe product is under costed by Rs 80. In
case of Regular product the cost per unit production as per traditional approach is overcasted

Activity Application Rate Deluxe (2000) Regular (8000)

Non Amount Non Amount
Fin Rs Fin Rs
Material Receipt 200 per receipt and 150 30,000 200 40,000
and Movement movement
Production Setup 8,000 per production 25 2,00,000 50 4,00,000
set up
Inspection and 30,000 per 4 1,20,000 6 1,80,000
Quality Check inspection and
quality check
Shipment 200 per shipment 50 10,000 100 20,000
Total 3,60,000 6,40,000
Cost per unit 180 80
as the cost per unit is Rs 210 whereas as per activity based costing the cost per unit of Regular
product is 190, ie it is over costed by Rs.20. The Deluxe product is under costed by Rs 1,60,000
(2000x80) and Regular product is over costed by Rs 1,60,000 (8000x20).

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The unit cost for Deluxe product is 29% higher under ABC as opposed to traditional absorption
costing. Under ABC, it is Rs 355 per unit compared to Rs 275 per unit under traditional costing.
This is particularly significant given that the selling price for Deluxe product is Rs 325 per unit.
This means that when the activities that give rise to the overhead costs for Deluxe product
are considered, Deluxe product is making a loss. If the company wants to improve profitability
it should look to either increase the selling price of Deluxe product or somehow reduce the
costs. The inspection and quality check cost for Deluxe product is the area where it can reduce
cost by reducing the number of checks which is 4 for mere 2000 units as compared to 6 checks
for 8000 units of Regular product. Similarly, Number of shipments is also required to be
managed. The unit cost for Regular product is 9.5% lower under ABC when compared to
traditional costing. The selling price for Regular product can also be increased to enhance
more profit.

Hence, if the company further decides as to maximize profit it can select Regular product and
divert the resources of Deluxe product towards Regular product and should discontinue
Deluxe product as it will results in more profit based on activity based costing technique.

Question#3: Prime Corp, a multi-product company, furnishes the following data relating to
the year 2020:

Particulars 1st Half 2nd Half

Amount (INR) Amount (INR)

Sales 75,000 1,00,000

Total Cost 50,000 60,000

Assuming that there is no change in prices and variable costs. Further, the fixed expenses are
incurred equally in the two half-year periods. You are required to calculate for the year:

a) Profit-Volume Ratio or Contribution to Sales Ratio for the year

b) Fixed Expenses for the year

c) BEP Sales for the year

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 d) Percentage Margin of Safety to Total Sales for 2nd Half.

Answer:
Calculation of Profit:
Profit = Sales - Total Cost
First Half = 75,000 – 50,000 = 25,000
Second Half = 1,00,000 – 60,000 = 40,000
Change in profit = 40,000 – 25,000 = 15,000
Change in Sales = 1,00,000 – 75,000 = 25,000

A. P.V ratio = Change in profit/ Change in sales = 15000/25000 = 60%

B. Fixed Expenses = Contribution – Profit
First Half Fixed Cost = [(75000* 60%) – 25,000] = Rs 20,000
Alternatively,
Second Half Fixed Cost = [(100000* 60%) – 40,000] = RS 20,000
Total Fixed Cost(including First half and second half) = 20,000+20,000 = RS 40,000
Or
Total Sales is 1,75,000
Contribution = 175000 X 60% = 1,05,000
Fixed Cost = Contribution - Profit
Fixed Cost = 1,05,000 – 65,000 (25,000 + 40,000)
= 40,000

C. BEP Sales = Fixed Cost/P.V ratio = 40000/60% = Rs 66,667

D. Percentage of Margin of Safety (MOS) to Total Sales for second Half

Margin of Safety =Profit/ P V ratio= 20000/60% = Rs.33,333 or,
Margin of Safety = Sales – BEP sales = 1,00,000 -33,333 = 66,666
Percentage of Margin of Safety = 66,666/100000*100 = 66.66 or 66.67%

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Question 4: This question is related to HBR Case Study – Dakota Office Product by Robert S.
Kaplan (102021-PDF-ENG).In this case - Dakota Office Products (Harvard Business School),
there are 6 multiple-choice questions. Each question contains four alternatives, out of which
only one alternative is correct. Please choose the correct option with proper explanation.

Please choose the correct option with proper explanation.

a) In order to limit losses and potentially make profits, which of the following strategies
should be implemented by DOP?

A. DOP should offer discounts to encourage customers to order electronically

B. DOP should charge an additional order processing fee from customers who
place small and more frequent orders in order to incentivize them to place
large orders

C. DOP should charge a certain level of interest rate for accounts receivables
longer than a threshold period, say 30 days

D. All of the above

Explanation: Statement D is true as all the above statements are true. If DOP offers
discounts to encourage customers to order electronically and more orders are coming
electronically which are less costly to serve will increase the profit of the Company. To
encourage the customers to place large orders so that the cost of serving them gets
reduced will also boost its profit. Since the company is operating under hard financial
budget constraint, charging certain level of interest rate on the delayed payments by the
accounts receivables will result in earlier release of money and in some interest income
which will reduce the overall finance cost.

b) In relation to the costs incurred by DOP, which activity accounts for the biggest
absolute difference between Customer A and Customer B?

A. Shipping cartons (commercial freight)

B. Shipping cartons (desktop delivery)

C. Processing orders (manual)

D. Entering line items (manual orders)

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 Explanation: Customer B placed many smaller quantity orders and around 25% of their
orders requested the desktop delivery option, which requires more shipping of cartons And,
this is causing the biggest absolute difference between the Customer A and Customer B.
This can be shown as per the following calculations:

c) How much interest rate (per annum) should DOP charge from Customer B on the
account receivables of $30,000 in order to achieve a profit of $0 (ceteris paribus)?

A. 1.6%

B. 8.4%

C. 10%

D. None of the above

Explanation: Interest at the rate of 8.4% on R$ 30,000 will be $ 2,520 which is to the amount
of loss contributed by the customer B. Hence, by charging interest @ of 8.4% then there will
be no loss or profit from customer B.

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 d) What will be the profit for DOP from Customer B if all its cartons are shipped via
commercial freight?

A. $0

B. $5200

C. $2680

D. $300

Explanation: Please analyze the below given table:

e) The per unit cost of processing EDI orders divided by the per unit cost of processing
orders manually is ______________

A. 10%

B. 50%

C. 100%

D. 200%

Explanation: The per unit cost of processing EDI order is $5 ($40 for 8 order) and per unit
cost of processing orders manually is $10 ($160 for 16 orders) Hence the percentage of
per unit cost of processing EDI orders as to per unit cost of processing orders manually
will be 50%.

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 f) What will be the profit from Customer A if DOP is not incurring any interest cost on its
account receivables?

A. $480

B. $4270

C. $5170

D. $6070

Explanation: The profit from customer A if DOP is not incurring any interest cost on its
account’s receivables will be $ 6070.

Question 5: Heavy Industrial Machines Limited uses ten units of Part No. T305 each month
to produce large diesel engines. The costs to manufacture one unit of Part No. T305 are given
below:

Direct material Rs. 20,000

Material handling (20% of direct material) Rs. 4,000

Direct labour Rs. 1,60,000

Manufacturing overhead (150% of direct labour) Rs. 2,40,000

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Material handling, which is not included in the manufacturing overhead, represents the direct
variable costs of the receiving department that are applied to direct materials and purchased
components on the basis of their cost. The Company’s annual manufacturing overhead
budget is one-third variable and two-thirds fixed. Workman Hydraulic Company, Australia,
one of the Company’s reliable vendors, has offered to supply Part No. T305 at a unit price of
Rs. 3,00,000. Material handling cost @ 20% of the purchase price will be incurred, as usual,
if the part is purchased from Workman Hydraulic Company.

Required:

Heavy Industrial Machines Limited is able to rent all idle capacity for Rs. 5,00,000 per month.
If the Company decides to purchase the 10 units of Part No. T305 from Workman Hydraulic
Company, what will be the effect on its profitability? Support your answer with necessary
calculations.

Solution:

Since cost of Manufacturing is less than direct buying, we should not buy.

Please note that fixed manufacturing cost is irrelevant because it does not change regardless
of the decision.

If the company can rent out all of its idle capacity for Rs 5,00,000 then

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While considering the rent amount, still the cost of manufacturing is less than cost of
direct buying. Given the analysis we continue manufacturing the product and should not
buy the product from the external vendor
Similarly, for the second part, we do not consider fixed manufacturing cost as it is irrelevant
because it does not change regardless of the decision.

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