The Winning Edge

PROBLEMS ON MARGINAL COSTING AND BREAK EVEN ANALYSIS

PROBLEM I ON MARGINAL COSTING

The following data have been extracted from the budgets and standard cost of ABC limited; a
company which manufactures and sells a single product.

Rs./per unit
Selling Price 45.00
Direct materials cost 10.00
Direct wages cost 4.00
Variable overhead cost 2.50
Fixed production overhead costs budgeted at Rs.4,00,000 per annum. Normal production
levels are budgeted at 3,20,000 units per annum.

Budgeted selling and distribution costs are as follows :

Variable Rs.1.50 per unit sold
Fixed Rs.80,000 per annum
Budgeted administration costs are Rs.1,20,000 per annum.

The following pattern of sales and production is expected during the first six months of the
year :
January-March April-June

Sales (units) 60,000 90,000

Production (units) 70,000 1,00,000
There is to be no stock on 1 January.

You are required: to prepare profit statements for each of the two quarters, in a columnar
format, using marginal costing, and absorption costing;

PROBLEMS ON BEP

Problem II
OWN OR RENT:

Akhil industries is contemplating a capital investment of Rs 300 Lakhs during current year. There
are two ways of funding the investment. The company can finance the investment by debt
carrying a rate of interest of 15% p.a. repayable in five equal annual installments alternatively it
can lease assets on following terms:
Lease term (5 years)
Annual lease Rental (per Rs. 1000)
Year Rs.
1 443
2 443
3 196
4 196
5 196
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The tax relevant rate of depreciation is 25% and marginal tax rate (inclusive of surcharge) is 46%.
The company anticipates substantial tax liabilities during the current years and in the following
year. Given that the objective of the company is to reduce term liability which of the alternatives
will you recommend?
Problem III

DECISION REGARDING CONSTRUCTION OF FACILITIES

Thomas Smith Ltd. Plants to construct some new buildings for installing certain additional
machinery acquired as part of their diversification programme. The companies can either
construct the buildings on their own or assign the construction work to an outside builder. It’s
estimated that the benefits to be received from the buildings would warrant the acceptance of a bid
for Rs. 12, 20,000 from any outside builder. The budget for manufacturing operations of the
company at normal capacity is as follows:

Rs.
Direct materials 20, 00,000
Direct labor 16, 00,000
Manufacturing overheads:
Fixed 6, 00,000
Variable 12, 00,000
Total 54, 00,000

It’s expected that the new buildings will be completed within a year and during this period, the
company can meet its targeted sales by operating at 60% capacity, while utilizing the remaining
capacity for construction of new building. The incremental costs of construction have been
estimated as follows:
Rs.
Direct material 6, 00,000
Direct labor 4, 00,000
Manufacturing overhead identified with construction 1, 50,000
Overheads identified with construction 50,000

How will manager take the decision as to whether the company has to construct the buildings or
whether they must contract it to an outside builder?

Problem IV

BREAK EVEN POINT ANALYSIS

Following are the details available, pertaining to Nakula company Ltd:-

Particulars Year 1 Year 2

Sales (Rs) 1,00,000 2,00,000
Profit (Rs) 40,000 90,000
Margin of Safety (Rs) 80,000 1,80,000

Compute the following:-

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A) B.E.P. sales for year 1 & year 2.
B) P/V ratio for year 1 & year 2.
C) Total fixed costs for year 1 & year 2.
D) Assuming that P/V ratio of year 2 will continue for year 3 what will be the sale of year 3 if
Profit of year 3 will be Rs. 1, 10,000.
E) If total fixed cost of year 2 increases by 50% in year 3 then what should be the change in
P/V. Ratio of year 2 in year 3 so that the B.E.P. sales of year 2 will be continued for year 3
also.
Problem V

Annual Production capacity of XYZ Co. Ltd. is 20,000 units for year ‘1’, following is the cost
structure:
Per Unit (Rs.)
Material 10
+ Wages 6
+ Variable overheads 4
TOTAL VAR. COST 20
+ Fixed overheads 4
TOTAL COST 24
+ Profit 6
SALES PRICE 30

During year ‘1’, the Co. produced & sold 5,000 units.

Compute the following for year ‘1’: -

i) P/V ratio
ii) B.E.P. Sales (in Rs.& units)
iii) Margin of Safety (in Rs. & units)

PRICING DECISIONS
Problem VI

XYZ Co. Ltd. Wishes to introduce a new product in the Market. You are required to advice the
Co. to select a Model on the basis of following information: -

Variable Cost (per unit) Model I Model II Model III

Rs. Rs. Rs.
1) Material 1.54 1.22 0.86
2) Labor 1.06 0.95 0.58
3) Variable Overheads 0.40 0.33 0.31
3.00 2.50 1.75
4) Selling Price (Per Unit) 4.25 3.50 2.50
5) Expected sales Vol./month (units) 800 200 4,000
6) Interest on Capital Exp. before Production can commence 800 3,000 4,000
(financed by bank O.D. @ 15% p.a. Interest rate)
7) Fixed Overheads per month attributable to new models 280 850 1,100
including depreciation on capital Exp. But excluding
Interest cost.

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Problem VII

Zee Co. Ltd. has the manufacturing capacity of 1, 00,000 units p.a. At the current operations level
of 50,000 units p.a. its annual budget is as under (in Rs.):

Sales 25,00,000
Costs: Variable 10,00,000
Fixed 10,00,000
Profit before Tax 5,00,000

It receives an export order for 40,000 units ones and above its current production. The special
costs incidental to exports are: special packaging = Rs. 1, 00,000, Documentation = Rs. 50,000. If
the management expects that the export should contribute at least Rs. 50,000 to Profit After Tax
(The tax rate is 50%) find out the minimum selling price.

Problem VIII

Astute Ltd. has submitted the following data:

(i) Its current capacity is 1,00,000 units
(ii) At its current level of operations its margin of safety is 50% of its’ breakeven point
(iii) The contribution margin (P/V ratio) is 25%
(iv) Sales price currently is Rs. 40 per unit
(v) The unutilized capacity at payment is 10,000 units.
a. Based on the above data compute the following
i. Break Even Point in sales value
ii. Fixed Cost
iii. Variable cost per unit
iv. Margin of safety in units
b. Astute Ltd. is seriously considering a proposal to reduce the price to Rs. 38. It
hopes that the increase in demand will help it utilize the capacity in full. Assuming
that the price decrease is applicable to the entire quantity, analyse whether the
increased sales would help to increase overall profit.
c. What level of price reduction would have no impact on profit?
d. If the fixed costs decline by Rs. 1, 80,000 to what extents can the price is reduced
to maintain the total profit at current level?

THE PRODUCT MIX DECISIONS

Problem IX

Wizard Ltd. Manufactures 3 products A, B & C, the relevant date for which are as follows:

Rs. A B C
Sales Price per unit 30 28 32
Cost data per unit 24 23 25
Raw Material 11 12 9
Direct Labour 4 6 7
Variable Overheads 9 5 9
M/c hours required/units 2 3 4

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The other constraints are:-

i) Total m/c hour capacity available is 50,000 m/c hours.
ii) Fixed overheads are Rs. 50,000/-.
iii) Following are the minimum and maximum quantities of each of the products that need
to be manufactured and sold:

Minimum Quantity 1,000 2,000 3,000

Maximum Quantity 20,000 15,000 11,000

Compute the maximum profit that can be achieved under the circumstances.

Problem X

The officers of a company are reviewing the profitability of its 4 products and the potential effect
of several proposals for varying the product mix. An excerpt from the Income statement and other
data are given below:

Total P R O D U C T S
P Q R S
Rs. Rs. Rs. Rs. Rs
Sales 62,600 10,000 18,000 12,600 22,000
Cost of goods sold 44,274 4,750 7,056 13,968 18,500
Gross profit 18,326 5,250 10,944 (1,368) 3,500
Operation Expenses 12,012 1,990 2,976 2,826 4,220
Income Before Taxes 6,314 3,260 7,968 (4,194) (720)
Units sold (no.) 1,000 1,200 1,800 2,000
Selling Price/Unit 10.00 15.00 7.00 11.00
Variable cost of goods sold/Unit 2.50 3.00 6.50 6.00
Variable operating expenses/unit 1.17 1.25 1.00 1.20

Each of the following proposals is to be considered independently of the other proposals. Find out
the effect on income if:
a) Product R is discontinued
b) Selling Price is increased to Rs. ‘8’ & no. of units sold is decreased to 1,500 of product R
c) The plant in which R is produced can be utilized to produce a new product whose variable
costs are Rs. 8.05 & 1600 units can be sold at Rs. 9.50 each
d) Part of the plant in which P is produced can easily be adapted to the production of S. But
changes in quantities require the selling prices. Production of P is to be reduced to 500
units (to be sold at Rs. 12 each) and production of S will be increased to 2,500 units (S.P.
Rs. 10.50/per unit)

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CASE STUDY ON FITWELL MANUFACTURERS

(Rs in lacs) A B C
Sales 300 1200 600
Costs
Raw material 75 350 145
Direct labour 75 280 140
Factory overhead- variable 20 110 55
Factory overhead- fixed 40 120 60
Selling & Dist Overhead - Variable 23 70 40
Selling & Dist Overhead - fixed 15 50 30
Admin overheads 20 90 40
Head office exp 12 50 30
TOTAL 280 1120 540
Profit 20 80 60

B C
a) Additional Fixed overhead due to increased capacity utilisation 40 lacs 50 lacs

b) Additional Freight & selling & other overhead to distribute the output Rs 35
Rs 25 per unit per unit

You are required to evaluate both the proposals and advise the management which one to undertake.