Revision Class Material

ADVANCED COST AND MANAGEMENT

ACCOUNTING

Compiled By CA Santosh Adhikari

 MARGINAL COSTING AND DECISION-MAKING PROBLEMS

Coverage:

❖ Marginal Costing
❖ Range BEP (Semi Variable Costs)
❖ Composite BEP
❖ Make or Buy Decisions
❖ Sub-contracting
❖ Key Factors/Product Mix Decisions
❖ Cost Indifference Point
❖ Temporary Shutdown vs Continuation
❖ Other Decision-Making Problems

Compiled By CA Santosh Adhikari

 MARGINAL COSTING

THEORY & CONCEPTS

➢ Marginal Cost
The cost of one unit of product or service which would be avoided if that unit were not produced
or provided. Marginal cost is the additional cost incurred by producing one more unit of a good or
service, reflecting the change in total cost as output changes incrementally.

➢ Marginal Costing
• Ascertainment of marginal cost and of the effect on profit of change in volume or type of output
by differentiating between fixed cost and variable cost.
• It is not a distinct method of costing as studied like job costing, process costing, etc. but a
technique used for a managerial decision making.

➢ Differential Cost
• Increase or decrease in total cost or the change in specific elements of cost that result from any
variation in operations.
• Only variable cost are relevant for decision making.
• Fixed cost are Sunk cost therefore, irrelevant for decision making.

➢ Distinguish between “Marginal cost” and ‘Differential Cost”.

Marginal Cost represents the increase or decrease in total cost which occurs with a small change
in output say, a unit of output. In Cost Accounting variable costs represent marginal cost.

Differential Cost is the change (increase or decrease) in the total cost (variable as well as fixed)
due to change in the level of activity, technology or production process or method of production.

In other words, it can be defined as the cost of one unit of product or service which would be
avoided if that unit was not produced or provided.

The main point which distinguishes marginal cost and differential as that change in fixed cost when
volume of production increases or decreases by a unit of production. In the case of differential cost
variable as well as fixed cost. i.e. both costs change due to change in the level of activity, whereas
under marginal costing only variable cost changes due to change in the level of activity.

➢ Cost-Volume-Profit (CVP Analysis)

• Cost Volume Profit Analysis (CVP Analysis) analyses inter-relationships among revenues,
costs, levels of activity and profits.
• It helps to analyze the variation in cost and profit due to change in the level of activity.

Compiled By CA Santosh Adhikari

➢ Income Statement under Marginal Costing
Sales XX
Less: V.C XX
Contribution XX
Less: F.C XX
Profit XX

➢ Contribution:
Contribution is the difference between Sales and Variable cost. It is the surplus amount generated
from sales of output towards fixed cost and profit.
Contribution = Sales – Variable cost
Contribution = Fixed Cost + Profit

➢ Profit Volume Ratio (P/V Ratio):

PV ratio is the ratio of contribution to sales and is usually expressed as a percentage. It indicates
the effect on profit for a given change in the sales. It is computed as follows:
P/V Ratio = Contribution/Sales x 100%
= (Sales – Variable cost) / Sales x 100%
= (1 – Variable cost ratio) x 100%
= (Fixed Cost + Profit)/Sales x 100%
= Change in Contribution/Change in sales x 100%
= Change in Profit (Loss)/Change in sales x 100%

➢ Breakeven Point:
Breakeven point refers to the business situation at which there is neither a profit nor a loss to the
organization. At this point, the total revenue of the organization is equal to the total cost of the
organization. BEP can be expressed in terms of units or value or percentage of sales. It is the
minimum sales units that is required to avoid the loss.
BEP (units) = Fixed cost/Contribution per unit
BEP (value) = Fixed cost / PV ratio
BEP (%) = BEP sales/Total sales x 100%

➢ Margin of safety:
The margin of safety is the difference between Actual sales and BEP sales. It represents those sales
units whose contribution generates profit for the organization. The size of Margin of safety
determines the financial strength of the organization. It can be expressed in terms of units or value
or percentage.
Margin of safety = Total sales – BEP sales
Margin of safety (units) = Profit/Contribution per unit
Margin of safety (value) = Profit/PV ratio
Margin of safety (%) = Margin of safety sales/Total sales x 100%

Compiled By CA Santosh Adhikari

 = 100% - BEP%

➢ Required sales for desired profit:

It represents the number of units to be sold or sales value to be achieved in order to earn desired
profit.
Sales (units) (Fixed costs + Profit)/Contribution per unit
Sales (value) (Fixed costs + Profit)/PV ratio

➢ Cash Break – even point.

Point of sales volume at which total revenue is equal to total cash cost.
𝐶𝑎𝑠ℎ 𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡
Cash BEP (in units) = 𝑃𝑉 𝑅𝑎𝑡𝑖𝑜

Note: It excludes non – cash items such as depreciation, notional rent, and deferred expenses.

➢ Breakeven chart:
A breakeven chart is a graphical representation of breakeven analysis that facilitates the
determination of Breakeven point, Margin of safety, Angle of incidence, Risk and Profitability of
the organization.

Angle of Incidence: This angle is formed by the intersection of sales line and total cost
line at the break even point. This angle shows the rate at which profits is earned once the
break even point is reached.

➢ Merged Plant / Company

Two or more company or plants operating at different capacity may be merged to gain the
synergy effect. The capacity of merged company is assumed to be utilized at 100% for the
purpose of CVP analysis.
𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑜𝑓 𝑎𝑙𝑙 𝑃𝑙𝑎𝑛𝑡𝑠/𝐶𝑜𝑚𝑝𝑎𝑛𝑖𝑒𝑠 𝑎𝑡 100% 𝑐𝑎𝑝𝑎𝑐𝑖𝑡𝑦
P/V Ratio = ×100
𝑇𝑜𝑡𝑎𝑙 𝑠𝑎𝑙𝑒𝑠 𝑜𝑓 𝑎𝑙𝑙 𝑃𝑙𝑎𝑛𝑡𝑠⁄𝐶𝑜𝑚𝑝𝑎𝑛𝑖𝑒𝑠 𝑎𝑡 100% 𝑐𝑎𝑝𝑎𝑐𝑖𝑡

Compiled By CA Santosh Adhikari

 𝐹𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑎𝑙𝑙𝑃𝑙𝑎𝑛𝑡𝑠⁄𝐶𝑜𝑚𝑝𝑎𝑛𝑖𝑒𝑠+𝐴𝑑𝑑𝑖𝑡𝑖𝑜𝑛𝑎𝑙 𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑀𝑒𝑟𝑔𝑒
BEP (in Rs.) = ×100
𝑃𝑉 𝑅𝑎𝑡𝑖𝑜 𝑜𝑓 𝑚𝑒𝑟𝑔𝑒𝑑 𝑝𝑙𝑎𝑛𝑡/𝑐𝑎𝑝𝑎𝑐𝑖𝑡𝑦

➢ BEP in case of semi variable/step fixed cost (Range BEP):

In case of semi variable overhead, BEP is calculated by following practical steps.
- Calculate BEP for fixed cost only without semi variable cost ( Considering SVC as Variable
Cost)
BEP = Fixed costs/New Contribution per unit
- Create range above BEP units as calculated in first step where semi variable cost behaves
as complete fixed cost.
-
- Calculate BEP for each range
BEP = (Fixed costs + Semi variable cost)/Contribution per unit
- BEP is such units that fall within provided range. It should be noted that in such case there
can be more than one BEP and all BEPs will be equally valid.

** Note: When BEP determined as the units of the upper most value of limit, then there will
be one more BEP on the next rage. As there will be one more BEP that falls in immediate next
range.

➢ Composite BEP:
If an organization produces and sells more than one type of output then in such case BEP will be
calculated by considering the overall quantity of products with their respective weight as follows:
Composite BEP (units) = Fixed costs/Weighted avg contribution per unit
Composite BEP (value) = Fixed costs/Weighted avg PV ratio
Individual BEP = Composite BEP X Sales ratio

➢ Product mix decision / Key factor / Limiting factor:

Key factor or Limiting factor is the element which limits the production activities of the
organization. There may be several such factors such as shortage of material, labor, production
capacity, working capital, etc.
If there is a limiting factor within an organization, then we have to allocate the resources in such a
manner that the product mix generates maximum profit. In order to achieve this objective, we have
to rank the products on the basis of contribution per unit of key factors of output. Contribution per
unit of key factor is calculated as follows:
Contribution p.u. of key factor= Contribution p.u./Key factor p.u.
Some of the examples of basis of ranking depending on key factor are:
Key Factor Basis of ranking

Compiled By CA Santosh Adhikari

 Sales Units Contribution per unit
Sales Value Contribution per unit of selling
price or PV ratio
Material Contribution per unit of material
Labor hours Contribution per labour hour
Machine hours Contribution per machine hour

➢ Cost indifference point:

It refers to that level of activity at which the total cost (fixed + variable) under two alternative
course of actions is same. At this point, management is indifferent to choose between two
alternatives. At this point the management is indifferent to choose between two alternatives.

Cost Fixed cost under Alternative 2 – Fixed cost under Alternative 1

indifference Variable cost p.u. under Alternative 1 – Variable cost p.u. under
= point (units) Alternative 2

Decision:
Below Indifference: Product with Lower Contribution (Low Fixed Cost; High VC)
Above Indifference: Product With Higher Contribution (High Fixed Cost; Low VC)
At Indifference Point: Either Option can be chosen.

➢ Make or Buy:
To decide whether a product should be made or bought, we will have to prepare Statement of
comparative cost and compare it,
Manufacturing Purchase
Cost to be incurred (Relevant cost) xxx Purchase price xxx
Add: Benefit to be lost xxx

The alternative with lower cost should be selected.

In case there are a number of components and a limiting factor then we should rank the products
on the basis of Savings per unit of key factor in order to decide which products should be
manufactured and which one should be purchased,
Particulars Product A Product B Product C
Manufacturing cost per unit xxx xxx xxx
Purchase cost per unit xxx xxx xxx
Savings in Manufacturing over Purchase xxx xxx xxx
Key Factor per unit xxx xxx xxx
Savings per unit of key factor xxx xxx xxx
Ranking

Compiled By CA Santosh Adhikari

➢ Sub contracting:
If a number of components are required to produce a finished product then we can choose either
to manufacture the components or subcontract to a third party. In order to decide which
components should be manufactured and which ones should be sub contracted, we will have to
prepare Statement of Ranking for the components.
Particulars Component A Component B Component C
Manufacturing cost(Variable) xxx xxx xxx
Purchase cost xxx xxx xxx
Savings of Mfg. over Purchase xxx xxx xxx
Limiting Factor p.u. xxx xxx xxx
Savings per limiting factor xxx xxx xxx
Ranking

The component that generates maximum savings per limiting factor should be manufactured
first. In case the variable cost of the component is more than the Subcontract or purchase price
then it is better to purchase the component.

➢ Temporary Shut down Vs Continuation:

If the production and sales is going to quite low for some period then we will have to decide
whether to temporarily shut down the operation or continue operation. This decision making deals
about reducing loss rather than making profit.

Shutdown point(units) = (Fixed costs – Shut down cost)/Contribution per unit

If the Production is more than Shut down point then continue operation otherwise temporary
shutdown will be better,

Compiled By CA Santosh Adhikari

 PRACTICAL PROBLEMS

1. A company gives the following information:

Margin of Safety Rs 3,75,000
Total Cost Rs 3,87,500
Margin of Safety (Qty.) 15,000 units
Break Even Sales in Units 5,000 units
You are required to calculate:
(i) Selling price per unit
(ii) Profit
(iii) Profit/ Volume Ratio
(iv) Break Even Sales (in Rupees)
(v) Fixed Cost
Solution:

(i) Selling Price per unit = Margin of Safety in Rs / Margin of Safety in Quantity
= Rs 3,75,000 / 15,000 units
= Rs 25
(ii) Profit = Total Units Sales Value – Total Cost
= Selling price per unit × (BEP units + MOS units) – Total Cost
= Rs 25 × (5,000 + 15,000) units – Rs 3,87,500
= Rs 5,00,000 – Rs 3,87,500
= Rs 1,12,500
(iii) Profit/ Volume (P/V) Ratio =Contribution Excess of BEP/Sales Excess of BEP
= Profit / Margin of Safety in Rs × 100
= Rs 1,12,500 / Rs 3,75,000 × 100 = 30%

(iv) Break Even Sales (in Rupees) = BEP units × Selling Price per unit
= 5,000 units × Rs 25
= Rs 1,25,000
(v) Fixed Cost = Contribution – Profit
= Sales Value × P/V Ratio – Profit
= (Rs 5,00,000 × 30%) – Rs 1,12,500
= Rs 1,50,000 – Rs 1,12,500
= Rs 37,500

2. MNP Ltd sold 2,75,000 units of its product at Rs 37.50 per unit. Variable costs are Rs 17.50 per
unit (manufacturing costs of Rs 14 and selling cost Rs 3.50 per unit). Fixed costs are incurred
uniformly throughout the year and amount to Rs 35,00,000 (including depreciation of Rs
15,00,000). there are no beginning or ending inventories.
Required:

Compiled By CA Santosh Adhikari

 (i) Estimate breakeven sales level quantity and cash breakeven sales level quantity.
(ii) Estimate the P/V ratio.
(iii) Estimate the number of units that must be sold to earn an income (EBIT) of Rs
2,50,000.
(iv) Estimate the sales level achieve an after-tax income (PAT) of Rs 2,50,000. Assume
40% corporate Income Tax rate.

Solution:

(i) Contribution = Rs 37.50 - Rs 17.50 = Rs 20 per unit.

Break even Sales Quantity = Fixed cost / Contribution margin per unit
= Rs 35,00,000 / Rs 20
= 1,75,000 units
Cash Break even Sales Qty = Cash Fixed Cost / Contribution per unit
= Rs 20,00,000 / Rs 20 = 1,00,000 units.

(ii) P/V ratio = 53.33%

(iii) No. of units that must be sold to earn an Income (EBIT) of Rs 2, 50,000 =(Fixed cost
+ Desired EBIT level) / Contribution margin per unit
=(35,00,000 + 2,50,000) / 20
= 1,87,500 units
(iv) After Tax Income (PAT) = Rs 2, 50,000
Tax rate = 40%
Desired level of Profit before tax =Rs 2,50,000 / 60 x 100 = Rs 4,16,667
Estimate Sales Level = (Fixed Cost + Desired Profit) / PV Ratio

= (Rs 35,00,000 + 4,16,667) / 53.33%

= Rs 73,43,750

3. A company produces single product which sells for Rs 20 per unit. Variable cost is Rs 15 per unit
and Fixed overhead for the year is Rs 6,30,000.
Required:
(a) Calculate sales value needed to earn a profit of 10% on sales.
(b) Calculate sales price per unit to bring BEP down to 1,20,000 units.
(c) Calculate margin of safety sales if profit is Rs 60,000.

Solution:

(a) Suppose Sales units are x

Compiled By CA Santosh Adhikari

 Then, S = V + F + P
(S = Sales ; V = Variable Cost; F = Fixed Cost; P = Profit)
Rs 20x = Rs 15x + Rs 6,30,000 + Rs 2x
Rs 20x – Rs 17x = Rs 6,30,000
X = Rs 630,000/3 = 2,10,000 Units
Sales value = 2,10,000 units × Rs 20 = Rs 42,00,000 to earn a profit of 10% on sales.

(b) Sales price to bring down BEP to 1,20,000 units B.E.P (Units) = Fixed Cost / Contribution per
unit
Or, Contribution per unit = 6,30,000 / 1,20,000 units
= Rs 5.25
So, Sales Price = Rs 15 + Rs 5.25 = Rs 20.25

(c) Margin of Safety Sales =Profit / PV Ratio Or, 60,000 / PV Ratio

where, P/V Ratio = 𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑝𝑒𝑟 𝑈𝑛𝑖𝑡 ×100

𝑆𝑃 𝑝𝑒𝑟 𝑈𝑛𝑖𝑡

Or, ×100 = 25%

Margin of Safety Sales = Rs 60,000 / 25% = Rs 2,40,000
So if profit is Rs 60,000, margin of safety sale will be Rs 2,40,000.

4. The following information is given:

Sales = Rs 200,000; variable cost= Rs 120,000; Fixed cost = Rs 30,000
Calculate:
(a) Break-even point
(b) New break-even point if selling price is reduced by 10%
(c) New break-even point if Variable cost increases by 10%
(d) New break-even point if fixed cost increases by 10%

Solution:
Profit Volume Ratio = (𝑆𝑎𝑙𝑒𝑠 – 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 Cost) / 𝑆𝑎𝑙𝑒𝑠 x 100%
= (200,000 – 120,000) / 200,000 x 100%
= 80,000 / 200,000 × 100%
= 40%
a) BEP = Total Fixed Cost / 𝑃𝑟𝑜𝑓𝑖𝑡 𝑣𝑜𝑙𝑢𝑚𝑒 𝑟𝑎𝑡𝑖𝑜
= 30,000 / 40%
= Rs 75000
b) When selling price is reduced by 10%

Compiled By CA Santosh Adhikari

 New sales = 200,000 - 10% of 200,000 =
Rs 180000
New Profit volume ratio = (Rs 180,000 – 120000) / Rs 180000 x 100%
= 33.33%
New Break − even point = Total Fixed Cost / 𝑃𝑟𝑜𝑓𝑖𝑡 𝑣𝑜𝑙𝑢𝑚𝑒 𝑟𝑎𝑡𝑖𝑜
= Rs 30,000 / 33.33%
= Rs 90000
c) When variable cost increases 10%:
New variable cost = Rs 120,000 + 10% of Rs 120,000
= Rs 132,000
New Profit Volume Ratio = (200,000 – 132,000) / 200,000 = 34%
New Break − even point = 30,000 / 34% = Rs 88,235(𝐴𝑝𝑝𝑟𝑜𝑥)
d) If fixed cost increases by 10%, new fixed cost = Rs 30,000 + 10% of Rs 30,000
= Rs 33,000
Profit volume ratio remains unaffected at 40%
New Break even point = Rs 33,000 / 40% = Rs 82,500

5. Following information are available for the year 2013 and 2014 of PIX Limited:
Year 2013 2014
Sales Rs 32,00,000 Rs 57,00,000
Profit/ (Loss) (Rs 3,00,000) Rs 7,00,000
Calculate:
(a) P/V ratio
(b) Total fixed cost
(c) Sales required to earn a Profit of` 12,00,000.
Solution:
(a) P/V Ratio = 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃𝑟𝑜𝑓𝑖𝑡 x 100%
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑆𝑎𝑙𝑒𝑠
= 𝑅𝑠 700000−(−300000) x 100%
5700000−3200000
= 40%
(b) Total Fixed cost = Total Contribution - Profit
= (Sales × P/V Ratio) – Profit
= (Rs 57,00,000 × 40%) - Rs 7,00,000
= Rs 22,80,000 – Rs 7,00,000
= Rs 15, 80,000
(c) Contribution required to earn a profit of Rs 12, 00,000 = Total fixed cost + Profit required
= Rs 15,80,000 + Rs 12,00,000
= Rs 27,80,000

Required Sales = Rs 27,80,000 / PV Ratio

Compiled By CA Santosh Adhikari

 = Rs 27,80,000 / 40%
= Rs 69,50,000

6. A manufacturing company produces Ball Pens that are printed with the logos of various companies.
Each Pen is priced at Rs 5. Costs are as follows:
Cost Driver Unit Variable Cost (Rs) Level of Cost Driver
Units Sold 2.50 -
Setups 225 40
Engineering hours 10 250

Other Data Total Fixed Costs (conventional): Rs 48,000

Total Fixed Costs (ABC): Rs 36,500

Required:
(i) Compute the break-even point in units using activity-based analysis.
(ii) Suppose that the company could reduce the setup cost by Rs 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 Units

1. [Fixed Costs + (Setup Cost ×Setups) + (Engineering Cost ×Engineering Hours)]/ (Sale
Price − Variable Cost)
= [36,500 + (Rs 225 × 40) + (Rs 10 × 250)] / (Rs 5 – Rs 2.50)
= 19,200 units

2. [Fixed Costs + (Setup Cost ×Setups) + (Engineering Cost ×Engineering Hours)]/ (Sale
Price − Variable Cost)
= [36,500 + (Rs 150 × 40) + (Rs 10 × 215)] / (Rs 5 – Rs 2.50)
= 17,860 Units

7. M.K. Ltd. manufactures and sells a single product X whose selling price is Rs 40 per unit and the
variable cost is Rs 16 per unit.
(i) If the Fixed Costs for this year are Rs 4,80,000 and the annual sales are at 60% margin
of safety, calculate the rate of net return on sales, assuming an income tax level of 40%
(ii) For the next year, it is proposed to add another product line Y whose selling price would
be Rs 50 per unit and the variable cost Rs 10 per unit. The total fixed costs are estimated
at Rs 6,66,600. The sales mix of X : Y would be 7 : 3. At what level of sales next year,
would M.K. Ltd. break even? Give separately for both X and Y the break even sales in
rupee and quantities.

Compiled By CA Santosh Adhikari

 Solution:
(i) Contribution per unit = Selling price – Variable cost
= Rs 40 – Rs 16
= Rs 24

Break-even Point = Rs 4,80,000/ Rs 24

= 20,000 units

Percentage Margin of Safety = (Actual Sales – Break even Sales)/Actual Sales

or, 60% = (Actual Sales – 20,000 units)/Actual Sales
Actual Sales = 50,000 units

(Rs)
Sales Value (50,000 units × Rs 40) 20,00,000
Less: Variable Cost (50,000 units × Rs 16) 8,00,000
Contribution 12,00,000
Less: Fixed Cost 4,80,000
Profit 7,20,000
Less: Income Tax @ 40% 2,88,000
Net Return 4,32,000
Rate of Net Return on Sales = 21.6%

(ii)
Product X (Rs) Product Y (Rs)
Selling Price per unit 40 50
Variable Cost per Unit 16 10
Contribution per Unit 24 40
Individual Products Contribution Margin 60% 80%
(24 / 40 x 100%) (40 / 50 x 100%)

Weighted Contribution Margin = 60% x 7/10 + 80% x 3/10

= 66%

Overall Break even Sales = Rs 10,10,000 (Rs 666600 / 66%)

Break even sales mix
X = 70% of Rs 10,10,000 = Rs 7,07,000 i.e. 17,675 units
Y = 30% of Rs 10,10,000 = Rs 3,03,000 i.e. 6,060 units

8. A Pharmaceutical company produces formulations having a shelf life of one year. The company
has an opening stock of 30,000 boxes on 1st January, 2005 and expected to produce 1, 30,000
boxes as was in the just ended year of 2004. Expected sale would be 1,50,000 boxes. Costing
department has worked out escalation in cost by 25% on variable cost and 10% on fixed cost. Fixed

Compiled By CA Santosh Adhikari

 cost for the year 2004 is Rs40 per unit. New price announced for 2005 is Rs100 per box. Variable
cost on opening stock is Rs40 per box. You are required to compute breakeven volume for the year
2005.

Solution
Shelf life is one year hence opening stock of 30,000 boxes is to be sold first. Contribution on these
boxes is 30,000(100 – 40) = Rs18,00,000.
In the question production of 2004 is same as in 2005. Hence fixed cost for the year 2004 is Rs52,
00,000 (1, 30,000×40). Therefore fixed cost for the year 2005 is Rs57, 20,000 (52,00,000 + 10%
of 52, 00,000).
Variable Cost for the year 2005 (Rs40 + 25% of Rs40) = Rs50 per Unit
Hence Contribution per unit during 2005 is Rs50 (100 – 50)
Break even volume is the volume to meet the fixed cost i.e. fixed cost equals to contribution.
Therefore, remaining fixed cost of Rs39, 20,000 (57, 20,000 – 18, 00,000) to be recovered from
production during 2005.
Production in 2005 to reach BEP = 3920000 / 50 = 78,400 units
Therefore BEP for the year 2005 is 1, 08,400 boxes (30000 + 78400)

9. Maryanne Petrochemicals Ltd. is operating at 80% capacity and presents the following
information:
Break - even sales Rs. 400 crores
P/V Ratio 30%
Margin of safely Rs. 120 crores

Maryanne's management has decided to increase production to 95% capacity level with the
following modifications:
a) The selling price will be reduced by 10%
b) The variable cost will be increased by 2% on sales
c) The fixed costs will increase by Rs. 50 crores, including depreciation on additions, but
excluding interest on additional capital.

Additional capital of Rs. 100 crores will be needed for capital expenditure and working capital.
Required:

i) Indicate the sales figure, with the working, that will be needed to earn Rs. 20 crores over and
above the present profit and also meet 15% interest on the additional capital.
ii) What will be revised
a) Break - even Sales
b) P/V Ratio
c) Margin of Safety

Solution:

Compiled By CA Santosh Adhikari

Working Notes:

1.Total Sales = Break - even Sales + Margin of Safety

= Rs. 400 crores + Rs. 120 crores
= Rs. 520 crores
2. Variable Cost = Total Sales x (1- P/V Ratio)
= Rs. 520 crores x (1 - 0.3)
= Rs. 364 crores

3. Fixed Cost = Break - even Sales x P/V Ratio

= Rs. 400 crores x 30%
= Rs. 120 crores
4. Profit = Total Sales - (Variable Cost + Fixed Cost)
= Rs. 520 crores - (Rs. 364 crores + Rs. 120 crores)
= Rs. 36 crores

i) Revised Sales figure to earn profit of Rs. 56 crores (i.e. Rs. 36 crores + Rs. 20 crores)
Revised Fixed Cost∗+Desired Profit
Revised Sales = Revised P/V Ratio∗∗
185 crores+ 56 crores
= 28%
= Rs. 860.71 crores

*Revised Fixed Cost = Present Fixed Cost + Interest on additional Capital

= Rs. 120 crores + Rs. 50 crores + 15% of Rs. 100 crores
= Rs. 185 crores
**Revised P/V Ratio: Let Current selling price per unit be Rs. 100.
Therefore, Reduced selling price per unit = Rs. 100 x90% = Rs.90
Revised Variable Cost on Sales = 70% + 2% = 72%
Variable Cost per unit = Rs.90 x 72% = Rs. 64.80
Contribution per unit = Rs. 90 - Rs. 64.80 = Rs. 25.20
Contribution 25.2
Revised P/V Ratio = × 100 × 100 = 28%
Sales 90

ii)
Fixed Cost 185 Crores
a) Revised Break - even Sales = × 100 = = Rs. 660.71 crores
P/VRatio 28%
b) Revised P/V Ratio = 28% (as calculated above)
c) Revised Margin of safety = Total Sales - Break even Sales
= Rs. 860.71 crores - Rs. 660.71 crores
= Rs. 200 crores

Compiled By CA Santosh Adhikari

10. [BEP in case of Semi-Variable Cost]
Satish Enterprises are leading exporters of Kid's Toys. J Ltd. of U.S.A. have 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 :
Rs.
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 Rs.400 per box.
Satish Enterprises will also have to import a special machine for making the toys. The cost of the
machine is Rs.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 Rs.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 Rs. 50 per $, you are required to :
i) Prepare a monthly and yearly profitability statements for the first year and second year
assuming the production at 3,000 today 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
(i) Profit Statement of M/s Satish Enterprises for first and second year on monthly and yearly
basis.
First Year Second Year
Monthly Yearly Monthly Yearly
Rs. Rs. Rs. Rs.
Sales revenue: (A) 600 7,200 600 7,200
(3,000 units × Rs. 200)
Material cost 180 2,160 180 2,160
(3,000 units × Rs. 60)
Labour cost 75 900 75 900
(3,000 units × Rs. 25)
Variable overheads 60 720 60 720
(3,000 units × Rs. 20)
Primary packing cost 45 540 45 540
(3,000 units × Rs. 15)

Compiled By CA Santosh Adhikari

 Boxes cost 24 288 24 288
Rs.3000
× 400
12 Months
Total fixed overhead 108 1,296 110 1,320
(Refer to working note 1) Rs. 1296 Rs. 1320
( )
12 Months 12 Months
Total cost: (B) 492 5,904 494 5,928
Profit : C = [(A) - (B)] 108 1,296 106 1,272

Working Note:
1. (i)
Fixed overhead year First year : (Rs.) Second (Rs.)

Depreciation 8,96,000 8,96,000

Rs. 2400000 + Rs. 288000 duty
3 years

Other fixed overheads 400000 4,24,000

Total fixed overheads 1296000 13,20,000

(ii) Statement of monthly break - even units of the first year.

Levels - No. of units (Refer to working 1351 -1400 1401 -1450 1451-1500 1501 -
note) 1500
Rs. Rs. Rs. Rs.
Fixed costs (A)
Total fixed, overheads per month (Refer 1,08,000 1,08,000 1,08,000 1,08,000
to working note)
Semi - variable costs (Special boxes 11,200 11,600 12,000 12,400
cost) - (B)
(28 boxes (29 boxes × (30 boxes × (31 boxes ×
× Rs.400) Rs.400) Rs.400) Rs.400)
Total fixed and semi variable costs : 1,19,200 1,19,600 1,20,000 1,20,000
(A+B)
Break-even level of units: 1490 1495 1500 1505
Total fixed and semi - variable costs (Rs. (Rs. (Rs. (Rs.
Contribution per unit 1,19,200 / 1,19,600 / 1,20,000 / 1,20,000 /
Rs.80) Rs.80) Rs.80) Rs.80)

The first and second break-even level of unit viz. 1490 and 1495 units falls outside the
range of 135-1400 and 1401 - 1450 units respectively. Here a monthly break-even level of
units is 1,500 units which lies in the range of 1451 - 1500 units.

Compiled By CA Santosh Adhikari

Statement of yearly break-even points of the first year
Levels - No. of units 17851-17900 17901-17950 17951-18000 18001-18050

Rs. Rs. Rs. Rs.

Fixed costs (A) 12,96,000 12,96,000 12,96,000 12,96,000

Semi -variable costs 1,43,200 1,43,200 1 ,44,000 1 ,44,000

(Special boxes cost) - (B)
(358 boxes × (359 boxes × (360 boxes × (361 boxes ×
Rs.400) Rs.400) Rs.400) Rs.400
Total fixed and semi 14,39,200 14,39,600 14,40,000 14,40,000
variable costs : (A+B)
Break-even level units: 17,990 17,995 18,000 18,005

(Rs. 1,19,200, / (Rs. 1,19,600 (Rs. 1,20,000 (Rs. 1,20,000 /

Rs.80) / Rs.80) / Rs.80) Rs.80)

Have a break-even level of units (on yearly basis) is 18,000 units which lies in the range of
17,951 -18,000 units as well. The other first two figures do not lie in the respective ranges,
so they are rejected.

Working note:
Rs.
1. Fixed overhead in the first year 12,06,000
Fixed overhead per month 1,08,000
Contribution per unit (S.P. per unit-VC per unit) 80
Hence, the break-even number of units will be above 1,350 units (Rs. 1,08,000 / Rs. 80)

iii) If the number of toys goes beyond the level of 1,500 numbers, one more box will be required
to accommodate each 50 additional units of toys. In that case the additional cost of a box will be
Rs.400/- this amount can be recovered by the additional contribution of 5 toys. Hence, the second
break-even point in such a contingency is 1,505 toys. (Refer to 1 (b) (ii) last column of first
statement).

iv) Comments: Yearly break-even point of 18,000 units of toys in the first instance is equal to 12
times the monthly break-even point of 1,500 units, because the monthly and yearly figures of
break-even point fell on the upper limit of the respective range. In the second instance, it is not so
because the monthly and early break-even point fell within the range of 50 toys.

Compiled By CA Santosh Adhikari

11. [Composite P/V Ratio and Composite BEP]
Veejay Ltd., makes and sells two products, Vee and Jay. The budgeted selling price of Vee is Rs.
1,800 and that of Jay is Rs.2,160. Variable costs associated with producing and selling the Vee are
Rs.900 and with Jay Rs. 1,800. Annual fixed production and selling costs of Veejay Ltd. are
Rs.88,000.
The company has two production/sales options. The Vee and Jay can be sold either in the ratio of
One Vees to three Jays or in the ratio of one Vee to two Jays. What will be the optimal mix and
why?

Solution
Statement of best optimal mix
Rs. Rs.
Budgeted selling price p.u. 1,800 2,160
Less: Variable cost p.u. 900 1,800
Contribution p.u. 900 360

(I) Production / Sales option: (1 unit of Vee and 3 units of Jays)

Total contribution under 1st option
= (1 units x Rs.900 + 3 units x Rs.360)
= Rs.900+ Rs.1, 080 = Rs.1980
Annual fixed Production & Selling costs
Break-even point = Total Contribution under 1st option
Rs. 88000
= Rs.1980 = 44.44 (sets of 3 units each)
Products
Vee Jay Total
Break-even point 44.44 × 1 units 44.44 × 2 units (units)
= 44.44 units = 88.88 units
= 44 (units approx.) = 89 (units approx.)
Break-even sales (Rs.) =79,200 =1,92,240 3,08,520

(61 units x Rs.1,800) (92 units x Rs.2,160)

(II) Production / Sales option: (1 unit of Vee and 2 units of Jays)

Total contribution under II option
= (1 unit × Rs.900 + 2 units × Rs.360)
= Rs.900 + Rs.720 = Rs.1 ,620
Break-even point
Rs. 88000
= Rs. 1620 = 54.32 (set of 3 units each)
Products
Vee Jay Total

Compiled By CA Santosh Adhikari

 Break-even point 54.32 × 1 unit 54.32 × 2 units
= 54 (units approx.) = 109 (units approx.)
Break-even sales (Rs.) = 97,200 =2,35,440 32,32,640
(54 units x Rs.1,800) (109 units x Rs.2,160)

Note :
The given amount of annual fixed production and selling cost is such that it fails to determine the
exact figure of break-even point under two given sales options. The approximations made in the
above solutions under option 1, at break-even sales level over recovers Rs.20; whereas under
option II of the solution there is an under recovery of fixed cost to the extent of Rs.150.

Decision and reasoning:

Option I is preferred over option II, as it results in a lower level of sales to reach break-even
(because of higher average contribution per unit sold). The average contribution per unit (under
option I) is Rs.576 Rs.2,880/5 units) and (under option II) it is Rs.540 (Rs.1,620/3 units). Option
I contains a higher percentage (40% as against 33 1/3%) of more profitable products.

12. Hewtax manufactures two products- tape recorder and electronic calculators and sell them
nationally. The Hewtax management is very pleased with the company's performance for the
current fiscal year. Projected sales through January 1, 1987, indicate that 70,000 tape recorders and
140,000 electronics calculators will be sold this year. The projected earning statement, which
appears below shows that Hewtax will exceed its earning goal of 9% on sales after taxes. Hewtax
Electronics projected Earnings Statement for the year ended-December 31, 1987.
Tape Recorder Electronic Calculator
Total
Total Total
Particulars Amount
Amount Per Unit Amount Per Unit
(‘000)
(‘000) (‘000)
Sales Rs 1050 Rs 15.00 Rs 3150 Rs 22.50 Rs 4200
Production Cost
Material 280 4.00 630 4.50 910.00
Direct Labour 140 2.00 420 3.00 560.00
Variable Overhead 140 2.00 180 2.00 420.00
Fixed Overhead 70 1.00 210 1.50 280.00
Total Production 630 9.00 1540 11.00 2170.00
Cost
Gross Margin Rs. 420 6.00 1610 11.50 2030.00
Fixed Selling and 1040.00
Administrative

Compiled By CA Santosh Adhikari

 Net Profit Before 990.00
Income Tax
Income Tax 55% 544.50
Net Income 445.50
The tape recorder business has been fairly stable in the last few years and the company does not
intend to change the tape recorder price. However the competition among manufactures of
electronic calculators has been increasing. Hewtax's calculators have been popular with
consumers. In order to sustain the interest in their calculators and to meet the price reductions
expected from competitors, management has decided to reduce the wholesale price of its calculator
from 22.50 to 20.00 per unit effective from January 1, 1988. At the same time the company plans
to spend an additional Rs. 57,000 on advertising during fiscal year 1988. As a consequence of this
action, management estimates that 80 per cents of its total revenue will be derived from Calculators
sales as compared to 75 per cent in 1987.
The total fixed production overhead costs will not change in 1988 nor will the variable overhead
cost rates (applied on a direct labour hour base). However, the cost of material and direct labour is
expected to change. The cost of solid state electronic components will be cheaper in 1988. Hewtax
estimated that material costs will drop by 10 per cent for the tape recorders and 20 per cent for the
calculators in 1988. However direct labour costs for both products will increase by 10 per cent in
the coming year.
Required
1. How many tape recorder and electronic calculator units did Hewtax Electronic have to sell
in 1987 to break even?
2. What value of sales is required if Hewtax Electronics is to earn a profit in 1988 equal to 9
per cent on sales after taxes.

Solution

Year 1987
Composite BEP (in units) = 𝑇𝑜𝑡𝑎𝑙 𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑎𝑙𝑙 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑠
𝐶𝑜𝑚𝑝𝑜𝑠𝑖𝑡𝑒 𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑝𝑒𝑟 𝑈𝑛𝑖𝑡

=
= 120000 units

Tape recorder = 40000 units

Electronic calculator = 80000 units

WN1: Contribution per Unit:

Tape recorder = 15- 4 – 2 -2 =Rs 7 / unit

Electronic calculator = 22.50-4.50-3.20 = Rs 13/unit

Compiled By CA Santosh Adhikari

 WN2: Composite Contribution per unit = ( 7 x7 + 14 x 13) / (7 + 14)

= Rs 11/unit

Year 1988:
Total Fixed Cost of all Products+Desired Profit
Targeted sales to earn desired profit = CompositeP⁄V Ratio
(280000+1040000+57000)+9% of Rs x x 1 (1−T)
x= 54%

x= Rs 4,050,000

Tape recorder (20%)= Rs 810,000

Electronic calculator = Rs 3,240,000

WN3: Composite P/V Ratio = .2 x 0.20+0.80

48+0.8 x 55.5
= 54%
WN4: Calculation of Individual Contribution/unit and Individual P/V Ratio
Tape recorder = 15 – 4 x 90% - 2 x 110% - 2 = Rs 7.20 / unit Electronic
calculator = 20 – 4.50 x 80% - 3 x 110% - 2= Rs 11.10 / unit
P/V Ratio:
Tape recorder = x 100% = 48%
Electronic calculator = x 100% =55.5%

13. The following are cost data for three alternative ways of processing the clerical work for cases
brought before the LC Court System:
A Semi-Automatic B Fully Automatic C Manual
(Rs) (Rs) (Rs)
Monthly fixed costs
Occupancy 15,000 15,000 15,00
Maintenance contract 0 3,000 10,000
Equipment lease 0 25,000 1,00,000
15,000 Unit 45,000 1,25,000
variable costs (per report):
Supplies Labour 40 80 20
5 hrs×40 1hr×60 0.25hr×80
or 200 or 60 or 20
240 140 40
Required
i) Calculate cost indifference points. Interpret your results.

Compiled By CA Santosh Adhikari

 ii) If the present case load is 600 cases and it is expected to go up to 850 cases in near
future, which method is most appropriate on cost considerations?

Solution
i) Statement of cost indifference points between ways of processing the clerical work for cases.
A and B A and C B and C
(Rs.) (Rs.) (Rs.)
Differential fixed costs: (I) 30,000 1,10,000 80,000
(Rs.45,000- (Rs.1,25,000- (Rs.1,25,000-
Rs.15,000) Rs.15,000) Rs.45,000)
Differential variable costs per case:(II) 100 200 100
(Rs.240-Rs.140) (Rs.240-Rs.40) (Rs.140-Rs.40)
Cost indifference point (I/II) 300 550 800
(Differential fixed costs / Cases Cases Cases
Differential variable costs per case)

Interpretation of results:
At activity level below the indifference points, the alternative with lower fixed costs and higher
variable costs should be used. At activity level above the indifference point alternative with higher
fixed costs and lower variable costs should be used. Thus, it expected number of cases is below
300, alternative A should be used. If expected number of cases are between 301 and 800 use
alternative B. If expected number of cases is above 800, use alternative C.

ii) Present case load is 600. Therefore, alternative B is suitable. As the number of cases is
expected to go up to 850 cases, alternative C is most appropriate.

14. A Co. Ltd. manufactures several different styles of jewelry cases. Management estimates that
during the third quarter, the company will be operating at 80 percent of the normal capacity.
Because the company desires a higher utilization of plant capacity, the company will consider a
special order.
The company has received special order inquiries from two companies. The first order is from JCP
Co. Ltd., which would like to market a jewellery case similar to one of A Co. Ltd.’s jewellery cases.
JCP jewellery case would be marketed under JCP’s own label. JCP Co. Ltd. has offered A Co. Ltd.
Rs.57.50 per jewellery case for 20,000 cases to be shipped by the last date of the quarter. The cost
data for A Co. Ltd. jewellery case that would be similar to the specifications of JCP special order
are as follows:
Rs.
Regular selling price per unit 90
Cost per unit
Raw Materials 25
Direct Labour 0.5 hour @ Rs.60 30
Overhead 0.25 machine hour @ Rs.40 10
Total Costs 65

Compiled By CA Santosh Adhikari

According to the specifications provided by JCP Co., the special order case requires less expensive
raw materials. Consequently the raw materials will only cost Rs.22.50 per case.
Management has estimated that the remaining costs, labour time and machine time will be the same
as for A Co. Ltd. jewellery case.
The second special order was submitted by K Co. Ltd. for 7,500 jewellery cases at Rs.75 per case.
These jewellery cases, like the JCP cases, would be marketed under K label and have to be shipped
by the last date of the quarter. However, the K Jewellery case is different from any jewellery case
in the A Co. Ltd. line. The estimated per unit cost of this case are as follows:
Rs.
Raw Materials 32.50
Direct Labour 0.5 hour @ Rs.60 30.00
Overhead 0.50 machine hour @ Rs.40 20
Total Costs 82.50
In addition, A Co. Ltd will incur Rs.15,000 in additional setup costs and will have to purchase a
Rs.25,000 special device to manufacture these cases, this device will be discarded once the special
order is completed.
The A Co. Ltd.’s manufacturing capabilities are limited to the total machine hours available. The
plant capacity under normal operations is 90,000 machine hours per year or 7,500 machine hours
per month. The budgeted fixed overhead for the Current year amounts to Rs.21,60,000. All
manufacturing overhead costs are applied to production on the basis of machine hours at Rs.40 per
hour.
A Co. Ltd. will have the entire quarter to work on the special orders. Management does not expect
any repeat sales to be generated from either special order. Company practice precludes from
subcontracting any portion of an order, when special orders are not expected to generate repeat
sales.
Required: Should A Co. Ltd. accept either special order? Justify your Solution and show the
calculations.
Solution
Statement showing profits on the acceptance of special orders in 4,500 unutilized hours (Refer to
working note 1)
Alternatives I II
JCP Co. Ltd. K. Co. Ltd.
Units made 18,000 7,500
Rs. Rs.
Selling price per unit 57.50 75.00
Less: Cost per unit 56.50 70.50
(Refer to working note 2)
Profit per unit 1.00 4.50
Total profit 18,000 33,750
(18,000 units × Re.1) (7,500 units × Rs.4.50)
Less: Costs of set up and special device NIL 40,000
Net Profit / (Loss) 18,000 (6,250)

Compiled By CA Santosh Adhikari

 Note: For special orders allocation of fixed overhead costs are not relevant.
Decision:
(i) If special order o JCP Co. Ltd. can be bifurcated, the company can supply 18,000 units of jewellery
cases and can earn additional profit of Rs.18,000. The remaining 2,000 units of order cannot be
met due to capacity constraint.
(ii) The special order from K. Co. Ltd. is not acceptable as it results into loss to the extent of Rs.6,250.

Working Notes:
1. Total unutilized hours during the third quarter
Total hours of third quarter 22,500
(7,500 hours × 3 months)
Hours utilized for 80% operating level 16,000
(22,500 hours × 80%)
Total unutilized hours during the third quarter 4,500

2. Computation of fixed and variable overhead rate

Fixed overheads per annum (Rs.) 21,60,000
Normal capacity hours 90,000
Fixed overheads rate per hour (Rs.) 24
(Rs.21,60,000 / 90,000 hours)
Manufacturing overhead application rate per hour (Rs.) 40
Therefore, variable overhead rate per hour Rs. 16
(Rs.40 – Rs.24)

3. Cost per unit of the order form JCP Col Ltd. and K. Co. Ltd.
JCP Co. Ltd. K. Co. Ltd.
Rs. Rs.
Raw materials cost per unit 22.50 32.50
Direct Labour 30.00 30.00
Variable overheads 4.00 8.00
(0.25 hours × Rs.16) (0.5 hours × Rs.16)
Total cost per unit 56.50 70.50

15. [Make or Buy Decision]

Panchwati Cement Ltd. produces ‘43 grade’ cement for which the company has an assured market.
The output for 2004 has been budgeted at 1,80,000 units at 90% capacity utilisation. The cost sheet
based on output (per unit) is as follows:
Rs.

Compiled By CA Santosh Adhikari

Selling price 130
Direct material 30
Component ‘EH’ 9.40
Direct wages @ Rs. 7 per hour 28
Factory overhead (50% fixed) 24
Selling and distribution overheads (75% variable) 16
Administrative overhead (fixed) 5
The factory overheads are applied on the basis of direct labour hours.
To utilise the idle capacity and to improve the profitability of the company, the following proposals
were put up before the Board of Directors for consideration:
(i) An order has been received from abroad for 500 units of product ’53 grade’ cement per month
at Rs. 175 per unit. The cost data are:
Direct material Rs. 56 per unit, direct labour 10 hours per unit, selling and distribution overhead
applicable to this product order is Rs. 14 per unit and variable factory overhead are chargeable
on the basis of direct labour hours.
(ii) The company at present manufactures component ‘EH’, one unit of which is required for each
unit of product ‘43 grade’. The cost details for 15,000 units of component ‘EH’ are as follows:
Rs.
Direct materials 30,000
Direct labour 52,500
Variable overheads 25,500
Fixed overheads 33,000
Total 1,41,000
The component ‘EH’ however is available for purchase at the market at Rs. 7.90 per unit.
(iii)In the event of company deciding to purchase the component ‘EH’ from market, the company
has two alternatives for the use of the capacity so released, which are as under:
(a) Rent out the released capacity at Re. 1 per hour.
(b) Manufacture component ‘GYP’ which can be sold at Rs. 8 per unit. The cost data of this
component for 15,000 units are:
Rs.
Direct materials 42,000
Direct labour 31,500
Factory variable overheads 13,500
Other variable overheads 25,500
Total 1,12,500

Required:
(i) Prepare a statement showing profitability of the company envisaged in the budget.
(ii) Evaluate the export order and state whether it is acceptable or not.

Compiled By CA Santosh Adhikari

(iii) Make an appraisal of proposal to manufacture component ‘EH’ and state whether the
component ‘EH’ should be manufactured in the factory or purchased from the market. Assume
that no alternative use of spare capacity is available.
(iv) Evaluate the alternative use of the spare capacity and state whether to manufacture or buy the
component ‘EH’ and if you decision is to buy the component ‘EH’, which of the two
alternatives for the use of spare capacity will you prefer ?
Solution
(i) Profitability as per original Budget
Rs (‘000s) Rs(‘000s)
Sales(1,80,000 unitsxRs 130) (A) 23,400
Direct Material (1,80,000 units xRs 30) 5,400
Component ‘EH’ ( variable cost = Rs 7.20 per unit) 1,296
Direct wages (1,80,000 units-Rs 28) 5,040
Variable factory overheads (1,80,000 units xRs 24x50% ) 2,160
Variable selling & distribution (1,80,000 unitsxRs 24x50% ) 2,160
Total variable cost (B) 16,056
Contribution (A – B) 7,344
Fixed factory overheads 2,160
Fixed selling & distribution overheads 720
Component ‘EH’ @2.20 396
Administrative overhead 900 4,176
Profit 3,168

(ii) Export order

Rs per Unit Rs per Unit
Direct material 56
Direct labour (10 hours-Rs 7 per hour) 70
Variable factory overhead ( Rs 3-10 labour hours) 30
Selling and distribution overheads 14
Total variable cost 170
Selling price (export) 175
Contribution 5
Since the product earns contribution of Rs.5 per unit, it should be accepted.
Total units 500(per month) = 6000 units(per annum)
Therefore additional contribution (6000 units-Rs 5) = Rs.30,000
Total hours on product ‘43 grade’ (1,80,000 units-4) = 7,20,000 Hrs
Total hours on component ‘EH’ (1,80,000 units-0.5*) = 90,000 Hrs
* Direct Labour cost
=
Rs 52,500
= 0.5 Hrs
No of units produced  Labour rate per hour 15,000 units  Rs 7 per hour
Total hours utilised at 90% capacity = 7,20,000 hours + 90,000 hours = 8,10,000 hours

Compiled By CA Santosh Adhikari

 100% capacity hours = 8,10,000 hours 100 = 9,00,000 Hrs
90
Balance hours available = 90,000 hours p.a
Hours required for export order 60,000 hours.
Both contribution per unit of export order and availability of capacity confirm its acceptance.
(iii) Component ‘EH’ make or buy
(per 15,000 units) Make (Rs.) Buy (Rs.)
Direct material 30,000
Direct labour 52,500
Variable factory overhead 25,500
Total 1,08,000 1,18,500
Per unit 7.20 7.90
If the company makes the component the out of pocket cost is Rs.7.20 per unit whereas if the
component is bought, the out of pocket cost is Rs.7.90.
Decision: If the capacity remains idle it is profitable to make.
(iv) Alternative use of the spare capacity
Units required = 1,80,000 units and hours required = 1,80,000 - 0 .5 = 90,000 Hrs
Cost of buying component ‘EH’ = (1,80,000 units - Rs 7.90) =Rs 14,22,000
Cost of making component ‘EH’ = (1,80,000 units - Rs 7.20) = Rs 12,96,000
Hence , excess cost of buying = Rs.1,26,000
Rent income (90,000 hours-Re1) = Rs.90,000
Contribution per unit from making component ‘GYP’ = Rs 8 - Rs 1,12,500 = Rs 0.5 per unit.
15,000 Units
Direct labour cost per unit of ‘GYP’ = Rs 31,500
= Rs. 2.10 per unit.
15,000 Units
No. of labour hours required for one unit of ‘GYP’ = Rs 2.10 = 0.3 Hrs
Rs 7
No. of units of ‘GYP’ in 90,000 hours = 90,000 hours = 3,00,000
0.3 hours
Contribution from component ‘GYP’ = 3,00,000 xRs 0.50 = Rs 1,50,000
Since the contribution from ‘GYP’ is greater than the extra variable cost of buying component ‘EH’
, component ‘GYP’ should be manufactured and component ‘EH’ should be purchased.

16. [Product Mix Decision]

A manufacturer produces three products whose cost data are as follows:
X Y Z
Direct materials (Rs. / Unit) 32.00 76.00 58.50
Direct Labour:
Deptt. Rate / hour (Rs.) Hours Hours Hours
1 2.50 18 10 20
2 3.00 5 4 7
3 2.00 10 5 20

Compiled By CA Santosh Adhikari

Variable overheads (Rs.) 8 4.50 10.50
Fixed overheads (Rs.) 4,00,000 per annum.
The budget was prepared at a time, when market was sluggish. The budgeted quantities and selling
prices are as under:
Product Budgeted quantity Selling Price / unit
(Units) (Rs.)
X 19,500 135
Y 15,600 140
Z 15,600 200
Later, the market improved, and the sales quantities could be increased by 20 per cent for product
X and 25 per cent each for product Y and Z. The sales manager confirmed that the increased sales
could be achieved at the prices originally budgeted. The production manager stated that the output
could not be increased beyond the budgeted level due to the limitation of Direct labour hours in
department 2.
Required:
(i) Prepare a statement of budgeted profitability.
(ii) Set optimal product mix and calculate the optimal profit.
Solution
Working Notes:
(Amount in Rupees)
X Y Z
Selling price per unit (A) 135.00 140.00 200.00
Variable costs per unit
Direct material 32.00 76.00 58.50
Direct labour
Department 1 45.00 25.00 50.00
Department 2 15.00 12.00 21.00
Department 3 20.00 10.00 40.00
Variable overheads 8.00 4.50 10.50
Total variable costs (B) 120.00 127.50 180.00
Contribution per unit (A×B) 15.00 12.50 20.00

(i) Statement of budgeted profitability

X Y Z
Budgeted quantity (units) 19,500 15,600 15,600
Contribution per unit (Rs.) 15.00 12.50 20.00
Total contribution (Rs.) 2,92,500 1,95,000 3,12,000
Contribution fund (Rs.) 7,99,500
Fixed overheads (Rs.) 4,00,000

Compiled By CA Santosh Adhikari

 Profit (Rs.) 3,99,500

(ii) Contribution per direct labour hour for Department 2

X Y Z
Contribution per unit (Rs.) 15.00 12.50 20
Direct labour hours per unit 5 4 7
Contribution per labour hour 3.00 3.125 2.857
Rank II I III

(iii) Total hours available in department 2

X 19,500 units x 5 = 97,500 hours
Y 15,600 units x 4 = 62,400 hours
Z 15,600 units x 7 = 1,09,200 hours
Total = 2,69,100 hours
Optimal Product Mix
Product Maximum Direct Hours Output Hours Balance
Sales labour per (units) used hours
(units) Hours unit
available
Y 19,500 2,69,100 4 19,500 78,000 1,91,100
X 23,400 1,91,100 5 23,400 1,17,000 74,100
Z 19,500 74,100 7 10,585 74,095 5

Optimal profit (Rs.)

Contribution (Rs.)
Y 19,500 x Rs. 12.50 = Rs. 2,43,750
X 23,400 x Rs. 15 = Rs. 3,51,000
Z 10,585 x Rs. 20 = Rs. 2,11,700
Total Contribution = Rs. 8,06,450
Less fixed cost = Rs. 4,00,000
Profit = Rs. 4,06,450

17. The Managing Director of a manufacturing company which produces three products has got the
following budget for the next year:
Particulars Products
P1 P2 P3
Number of units 15,000 10,000 20,000

Compiled By CA Santosh Adhikari

 Selling price (Rs./unit) 60 120 30
Profit/volume ratio 20% 40% 10%
Raw material cost as percentage to sales value 40% 35% 45%
Maximum sales units 20,000 15,000 25,000
The company uses the same raw material in all the three products and the price per kilogram of
the raw material is Rs. 2. The company envisages profit of 10% on the budgeted turnover before
interest and depreciation which are fixed. Interest and depreciation are estimated at Rs. 225,000
and Rs. 75,000 respectively. The raw material is in short supply and the budget proposes to make
full utilization of available raw materials.
The Managing Director is not satisfied with the budgeted profitability and has therefore passed
on the proposed budget to you as the Management Accountant of the company for review.
As a Management Accountant of the company,
You are required to:
i) Set an optimal product mix for the next year and find its profit,
ii) The company has been able to find a source for the purchase of an additional 18,000
kilograms of raw materials at an increased price. The transport cost of this additional
raw material is Rs. 9,000. What is the maximum price per kilogram that can be offered
by the company for the additional quantity of raw material?

Answer:
Statement of Contribution per kg. Of Raw Material and Ranking of Products
S. Details Products
No.
P1 P2 P3
1. Sales 900,000 1,200,000 600,000
2. P/V Ratio 20% 40% 10%
3. Contribution 180,000 480,000 60,000
4. Number of units 15,000 10,000 20,000
5. Contribution per unit (Rs.) [3/4] 12 48 3
6. Selling price (Rs./per unit) 60 120 30
7. Raw material cost as % to sales value 40% 35% 45%
8. Raw material cost per unit (Rs.) [6 x 7] 24 42 13.50
9. Consumption of material per unit in kg. (8/Rs. 12 21 6.75
2)
10. Contribution per kg. (5/9) 1.00 48/21 0.44
11. Ranking based on contribution per kg. II I III

Computation of Materials Available at Current Level of Production

Product No of Units Consumption per unit Total Consumption (kg.)
Produced (in kg.)

Compiled By CA Santosh Adhikari

 P1 15,000 12 180,000
P2 10,000 21 210,000
P3 20,000 6.75 135,000
Total: 525,000
(i) Optimum Product Mix for Next Year
Product Maximu Propose Consump- Material Material Contribution (in Rs.)
m d Units tion per used Balance Per kg. Total
Number unit (kg.) (kg.) (kg.)
P2 15,000 15,000 21 315,000 210,000 48/21 720,000
P1 20,000 17,500 12 210,000 Nil 1.00 210,000
Total Contribution 930,000
Less: Fixed Cost (See Note below) 750,000
Profit for Optimal Product Mix 180,000
Note:
Turnover: Rs. 2,700,000
Profit before interest and depreciation: Rs. 270,000
Less: Interest and deprecation: Rs. 300,000
Loss: Rs. 30,000
We know that, Sales – Variable cost = Fixed cost + Profit
Or Contribution = Fixed cost + Profit, Or Contribution = Fixed cost – Loss
Or Contribution + Loss = Fixed cost
Contribution as shown in the first table = 180,000 + 480,000 + 60,000 = Rs.
720,000 Thus, Fixed cost = Rs. 720,000 + Rs. 30,000 = Rs, 750,000

(ii) Maximum Price per kg. that the Company can offer for Additional Quantity of
Material
Raw material cost of P1
Rs. 24 Price per kg.
Rs. 2
Raw material consumed per unit of P1 (24/2) = 12 kg.
Additional quantity which can be produced (18,000/12) = 1,500 units
Since only, 17,500 units will be produced in the optimum production plan proposed
in (i) and maximum production units is 20,000 units, the company can purchase the
available additional quantity of raw materials for production of P1 product.
Contribution per unit of P1 is Rs. 12 per unit
Contribution of 1,500 units of P1 will be 1,500 x 12: Rs. 18,000
Less: Transportation cost: Rs.
9,000 Balance of contribution available for price increase:

Compiled By CA Santosh Adhikari

 Rs. 9,000 Maximum additional price = Rs. 9,000/18,000 =
Rs. 0.50 per kg.
Thus, the maximum additional price that can be paid for additional
material available = Rs. 2 + Rs. 0.50 or Rs. 2.50 per kg.

18. A company produces four products, P1, P2, P3 and P4 which are marketed in cartons. Of the total
of 20 machines installed, 8 are suitable for manufacturing all the four products and the remaining
12 machines are not suitable for the manufacture of product P1 and P4.
Each machine is in production for 300 days a year and each is used on a given product in terms of
full days and not in fraction of days. The company, however, has no problem in obtaining adequate
supplies of labour and raw materials.
As per the marketing policy of the company, all four products are to be sold and the minimum
annual production shall be 3,000 cartons for each product. Fixed costs budgeted amount to Rs. 5
million. The data related to production cost and price is as shown below:
Particulars P1 P2 P3 P4
Production/day/machine (Cartons) 14 4 3 6
Selling price /Carton Rs. 810 Rs. 790 Rs. 845 Rs. 1,290
Cost : Process I
Direct Material /Day /Machine 140 52 45 84
Direct Labour / Day /Machine 224 148 90 132
Process II
Direct Material /Carton 30 30 30 30
Direct Labour /Carton 240 216 300 360
Variable Overheads /Carton 390 390 300 720

With a view to meeting the increasing demand for products P1 and P4, the company is
contemplating to convert such number of machines as may be necessary out of the 12 machines
which at present are unsuitable to produce products P1 and P4 into all-purpose machines. The cost
of conversion of these machines is Rs. 210,000 per machine. The expenditure is to be amortised
over a period of three years. The company expects 12.5% return on this expenditure.
Market research has indicated that the company‘s sales of products P1 and P4 can be increased to
37,500 cartons and 5,400 cartons respectively. Similarly, the sales of product P3 can be increased
up to three times the minimum annual production level if needed.
Required:
a) Calculate the optimum profit of the company if the existing machines were
worked on most profitable basis before conversion.
b) Recommend the maximum number of machines to be converted into all-
purpose machines giving supporting calculations.
c) Calculate for the first year the optimum profit of the company after conversion
of the required number of machines into all-purpose machines.

Compiled By CA Santosh Adhikari

Answer:
Contribution per Carton and per Machine Day
Products → P1 P2 P3 P4
Cartons /Day /Machine 14 4 3 6
Minimum Sales 3,000 3,000 3,000 3,000
No. of days required for minimum sales 215 750 1,000 500
Sales /Carton (Rs.) 810 790 845 1,290
Process 1: Direct Materials 10 13 15 14
Direct Wages 16 37 30 22
Process 2: Direct Materials 30 30 30 30
Direct Wages 240 216 300 360
Variable Overhead 390 390 300 720
686 686 675 1,146
Contribution / Carton 124 104 170 144
Contribution /Machine Day 1,736 416 510 864

Optimum Mix before Conversion

The number of all-purpose machines is 8. Thus, machines hours available (300 x 8) = 2,400
days.
Since contribution /machine day is higher for product P1 (Rs. 1,736), the company should
produce minimum quantity of P4 and utilize the remaining days to produce maximum units
of product P1.
Thus, to produce minimum units of P4, number of days required = 500. The remaining days
available to produce product P1 (2,400 – 500) = 1,900. Number of cartons of P1 that will be
produced in the available days (1,900 x 14) = 26,600
Similarly, days available for other machines = 12 x 300 = 3,600
Since contribution /machine day is higher for product P3 (Rs. 510) as compared to P2.
(Rs. 416), the company should produce minimum quantity of P2 and utilize the remaining
days to produce maximum units of product P3.
Thus, to produce minimum units of P2, the number of days required = 750. The remaining
days available for the production of P3 (3,600 – 750) = 2,850. Number of cartons of P2 that
will be produced in the available days (2,850 x 3) = 8,550.

(a) Optimum Profit before Conversion

Products → P1 P2 P3 P4
Number of Cartons 26,600 3,000 8,550 3,000
Contribution /Carton (Rs.) 124 104 170 144
Total Contribution (Rs.) 3,298,400 312,000 1,453,500 432,000
Total Contribution of all the products (Rs.) 5,495,900

Compiled By CA Santosh Adhikari

 Fixed Costs (Rs.) (-) 5,000,000
Profit (Rs.) 495,900
(b) Maximum Number of Machines to be Converted.
After conversion of machines to all-purpose machines, production of P1 can go up to 37,500
cartons and production of P4 can be increased to 5.400 cartons. Thus,
P1 P4
Total cartons after conversion 37,500 5,400
Less: Existing optimum production before conversion 26,600 3.000
Additional units to be produced after conversion: 10,900 2,400
Number of cartons per day 14 6
Number of days required 779 400
The total number of days required (779 + 400) = 1,179, say, 1,200 days. The number of
machines to be converted (1,179 /300) 3.93, say, 4 machines since the machines to be
converted cannot be in fraction.

(c) Optimum Profit in the First Year after Conversion Optimum product mix after conversion:
Product Optimum Mix after Number of Machine Days Remarks
Conversion (Cartons) Days Required
P1 37,500 14 2,679
P2 3,000 4 750
P3 5,013 3 1,671 Machine days
derived as
balancing figure
P4 5,400 6 900
Maximum Hours Available (20 x 30 0) 6,000

Optimum Profit based on above Product Mix

Products → P1 P2 P3 P4
Number of Cartons 37,500 3,000 5,013 5,400
Contribution /Carton (Rs.) 124 104 170 144
Total Contribution (Rs.) 4,650,000 312,000 852,210 777,600
Total Contribution of all the products (Rs.) 6,591,810
Fixed Costs (Rs.) (-) 5,000,000
Profit (Rs.) 1,591,810
Amortisation of conversion cost of 4 machines (210,000 x 4) / 3 280,000
1,311,810
Earlier Profit before Conversion of Machines 495,000
Extra Profit after conversion of machines 815,910

Compiled By CA Santosh Adhikari

 Less: Minimum Profit @ 12.5% on Expected Investment of (105,000)
Rs. 840,000.
Extra Margin of Profit Available due to Conversion 710,910

19. [Temporary Shutdown vs Continuation]

If Moonlite Limited operates its plant at normal capacity it produces 2,00,000 units from the plant
'Meghdoot'. The unit cost of manufacturing at normal capacity is as under:
Rs.
Direct material 65
Direct labour 30
Variable overhead 33
Fixed overhead 7
135
Direct labour cost represents compensation to highly skilled workers, who are permanent
employees of the company. The company cannot afford to lose them. One labour hour is required
to complete one unit of the product.
The company sells its product for Rs. 200 per unit with variable selling expenses of Rs. 16 per
unit. The company estimates that due to the economic downturn, it will not be able to operate the
plant at normal capacity, at least during the next year. It is evaluating the feasibility of shutting
down the plant temporarily for one year.
If it shuts down the plant, the fixed manufacturing overhead will be reduced to Rs. 1,25,000. The
overhead costs are incurred at a uniform rate throughout the year. It is also estimated that the
additional cost of shutting down will be Rs. 50,000 and the cost of re-opening will be Rs. 1,00,000.
Required:
Calculate the minimum level of production at which it will be economically beneficial to continue
to operate the plant next year if 50% of the labour hours can be utilized in another activity, which
is expected to contribute at the rate of Rs. 40 per labour hour. The additional activity will relate to
a job which will be offloaded by a sister company only if the company decides to shut down the
plant.
(Assume that the cost structure will remain unchanged next year. Ignore income tax and time
value of money)
Answer
Contribution per unit
Particulars (Rs.)
Selling Price 200
Variable Cost (Rs. 65 + Rs. 33 + Rs. 16) 114
Contribution per unit (Excluding direct labour, considered 86
irrelevant and fixed)
Savings and earnings if the plant is shut down

Compiled By CA Santosh Adhikari

 Particulars Rs.
Savings in Fixed Cost (Rs. 14,00,000* – Rs. 1,25,000) 12,75,000
Contribution from Alternate Activity (Rs. 40 x 50% of 40,00,000
2,00,000 hrs)
Shutting Down and Reopening Cost (Rs. 50,000 + (1,50,000)
Rs.100,000)
Total 51,25,000
* [2,00,000 units x Rs. 7]
Indifference Point: Rs.51,25,000 / Rs.86 = 59,593 units
Minimum level of production to justify continuation = 59,594 units

20. In 19×1, the turnover of a company, which operated at a margin of safety of 25% amounted to
Rs.9,00,000 and its profit volume ratio was 33-1%. During 19×2, the company estimated that
although the same volume of sales as in 19×1 would be maintained, the sales value would go down
due to decrease in selling price. There will be o change in variable costs. The company proposes
to reduce its fixed costs through an intensive cost reduction program. These changes will alter the
profit volume ratio and margin of safety to 30% and 40% respectively in 19×2.
Even if the company closed down its operations in 19×2, it would incur a minimum fixed cost of
Rs.50,000.
Required:
(i) Present a comparative statement indicating the sales, variable costs, fixed costs and profit for
19×1 and 19×2.
(ii) At what minimum sales will the company be better off by locking up in business in 19×2?
Solution

(i) Comparative Statement (indicating sales, variable costs, fixed costs and profit)
Year 19×1(Refer to working note 1) 19×2(Refer to working note2)
Rs. Rs.
Sales 9,00,000 8,57,143
Variable costs 6,00,000 6,00,000
Fixed costs 2,25,000 1,54,286
Profit 75,000 1,02,857

(ii) Minimum sales at which the company will be better off if it locks up minimum fixed cost of
Rs.50,000 when company closed down its operation in 19×2.
Relevant fixed production costs in the year 19×2 Rs.1,04,286
(Rs.1,54,286 – Rs.50,000)
Minimum sales required to recover the relevant fixed cost is Rs.3,47,620
(Contribution / P/V ratio) or (Rs.10,04,286 / 30%)
Working Notes:
1. Year 19×1 Rs.

Compiled By CA Santosh Adhikari

 Sales: (A) 9,00,000
Variable cost: (B) 6,00,000
(66 – 2/3% of sales)
Contribution: C = {(A) – (B)} 2.00,000
Break even sales 6,75,000
(75% of sales is break even sales as margin of safety is 25%)
Fixed cost: (D) 2,25,000
(B.E.S. × P/V ratio)
(Rs.6,75,000 × 33 – 1/3%)
Profit : {(C) – (D)} 75,000

2.
(a) Year 19×2
Sales (A)
Variable costs : (A) 6,00,000
(as it remains same and equals that of year 19×1)
Contribution : (C) = (A – V) (x – 6,00,000)
Since P/V ratio = Contributi on
Sales
30x
 = (x – 6,00,000)
100
On solving above relations: x (sales) = Rs.8,57,143 (approx)
(b) Sales (A) 8,57,143
Variable costs : (B) 6,00,000
Contribution : C = (A – B) 2,57,143
Break even sales 5,14,286
(60% of sales)
Fixed costs: (D) 1,54,286
(B.E.S. × P/V ratio)
Profit (C – D) 1,02,857

21. [Sub-Contracting]
ABCD Ltd. produces and sells four brands of OPC cement. All these four brands are well
established and have a good reputation among the users. The company employs 2200 semiskilled
labourers in production with a maximum annual capacity of 550,000 direct labour hours. In the
past years, the company has faced the labour problem which had negatively impacted on its
effective production capacity. During the last financial year, industrial action resulted in the loss
of 20% of that capacity. In planning for the new financial year, it is recognized that further
industrial action remains a possibility. Therefore, the company doubts in reaching effective
production capacity. Besides, the economy is favoring the company since the demands of

Compiled By CA Santosh Adhikari

construction materials are increasing day by day. In the mid of the doubt and the expectation, the
company, however, intends to achieve the effective production capacity to meet the expected
demand. Therefore, the following sales and cost data for the financial year 2071/72 is forecasted:

Particulars Cement
Brands
A B C D
Sales (sacks of 50 Kg.) 65,000 70,000 75,000 40,000
Selling Price per sack (Rs.) 720 710 685 675
Costs per sack (Rs.):
Raw Materials 450 415 400 395
Variable Manufacturing Cost 100 110 120 135
Allocated Fixed Costs 125 150 125 135

To materialize the forecast by addressing the labor problem, the company has made a provision for
the recruitment of some sub-contract labor. And, 35,000 hours of capacity of sub-contract labour
over the year has been identified and negotiated.

Further, it is also planning to identify other manufacturers who might be able to assist in the event
of demand exceeding the company's ability to supply. During this process, the company has been
successful in identifying another manufacturing company who is prepared to produce cements to
meet the company's excess demand. The other manufacturer has quoted the following prices for
the production and supply of OPC cements meeting ABCD Ltd's precise specifications:

Brand A B C D
Quoted Price (In Rs. for per sacks of 50 Kg.) 690 685 660 645

The following information is also available:

a) Variable manufacturing costs are incurred at a rate of Rs. 50 per direct labour hour. They
include both labour costs and variable manufacturing overheads.
b) Fixed cost is allocated across the brands, according to the space occupied by the work-
in-progress for each product line.

ABCD Ltd. also manufactures PPC cements. Market study has indicated that customers may often
choose to purchase PPC cements of the company to complete the construction economically and
with trust. But, there is constraint on expansion of this product line due to the lack of available
space within the factory.

Required:
i) For the financial year 2071/72, what do you think is the limiting factor on the company's
ability to meet the sales forecast? Quantify it.

Compiled By CA Santosh Adhikari

ii) Work out the optimal production plan for the financial year 2071/72 without considering
the procurement from the other manufacturer. Compute the expected level of profitability
arising from the implementation of this plan.

iii) Work out the optimal production and purchasing plan for the financial year 2071/72
considering the procurement from the other manufacturer. Compute the expected level of
profitability arising from the implementation of this plan.

iv) Give any two appropriate reasons to opt for production plan along with purchase from
other manufacturer.

Answer
(i) Identification and quantification of the limiting factor:
Particulars A B C D Total
Variable mfg. costs (excluding raw
materials) (Rs.) 100 110 120 135
Variable mfg. costs per labor hour
50 50 50 50
(Rs.)
Labor hours per sack 2.00 2.20 2.40 2.70
Forecast sales – Sack 65,000 70,000 75,000 40,000
Total labor hours required 130,000 154,000 180,000 108,000 572,000
Actual labor hours available:
Effective capacity (550,000 hours
440,000
× 80%)
Subcontract labor 35,000
Total labor hours available 475,000
Shortfall labor hours 97,000
Conclusion:
As anticipated, the limiting factor is direct labor hours with a shortfall of 97,000 hours.
(ii) Statement showing contribution per labor hour (limiting factor) and product ranking
Particulars A B C D
Selling price per sack (Rs.) 720 710 685 675
Variable cost per sack (Rs.): Material
450 415 400 395
Manufacturing costs 100 110 120 135
Total variable cost per sack (Rs.) 550 525 520 530
Contribution per sack (Rs.) 170 185 165 145
Labor hours per sack 2.00 2.20 2.40 2.70
Contribution per labor hour per sack (Rs.) 85.00 84.09 68.75 53.70

Compiled By CA Santosh Adhikari

 Ranking I II III IV
Optimal production plan:

Particulars Sacks Labor hrs./sack Hours used Balance hrs.

Total labor hours
- - - 475,000
available
Production of Brand A 65,000 2.00 130,000 345,000
Production of Brand B 70,000 2.20 154,000 191,000
Production of Brand C 75,000 2.40 180,000 11,000
Production of Brand D 4,074 2.70 11,000 -
Contribution per sack
Cement brand No. of sacks Total contribution (Rs.)
(Rs.)
A 65,000 170 11,050,000
B 70,000 185 12,950,000
C 75,000 165 12,375,000
D 4,074 145 590,730
36,965,730
Fixed costs 33,400,000
Net Profit 3,565,730
Profitability forecast without procurement from the other manufacturer:

Working note:
Calculation of fixed costs:
Particulars A B C D Total
Production (sacks) 65,000 70,000 75,000 40,000 -
Fixed costs per sack -
125 150 125 135
(Rs.)
Total fixed costs 33,400,000
(Rs.) 8,125,000 10,500,000 9,375,000 5,400,000

(iii) Procurement from other manufacturer shall be made only where the costs saving by
own production is the lowest; or the production should be made when the cost saving
by production is higher. And, purchase should be made after full utilization of
available labor hours (475,000 hours) in own production on the basis of ranking of
cost saving.
Statement showing cost saving by own production and product ranking
Particulars A B C D
Purchase price per sack (Rs.) 690 685 660 645

Compiled By CA Santosh Adhikari

 Variable costs of production (Rs.): Material
450 415 400 395
Manufacturing costs 100 110 120 135
Total variable cost per sack (Rs.) 550 525 520 530
Savings per sack from own production (Rs.) 140 160 140 115
Labor hours per sack 2.00 2.20 2.40 2.70
Cost saving per labor hour per sack (Rs.) 70.00 72.73 58.33 42.59
Ranking for own production II I III IV

Statement showing contribution from purchasing:

Particulars A B C D
Selling price per sack (Rs.) 720 710 685 675
Purchase price per sack (Rs.) 690 685 660 645
Contribution per sack (Rs.) 30 25 25 30

Particulars Sacks Labor hrs./sack Hours used Balance hrs.

Total labor hours available - - - 475,000
Production of Brand B 70,000 2.20 154,000 321,000
Production of Brand A 65,000 2.00 130,000 191,000
Production of Brand C 75,000 2.40 180,000 11,000
Production of Brand D 4,074 2.70 11,000 -

Optimal production plan:

Number of sacks of Brand D to be purchased from the other

manufacturer: 40,000 sacks – 4,074 sacks = 35,926 sacks.

Profitability forecast considering procurement from other manufacturer:

Contribution per sack
Cement brand No. of sacks Total contribution (Rs.)
(Rs.)
A 65,000 170 11,050,000
B 70,000 185 12,950,000
C 75,000 165 12,375,000
D* 4,074 145 590,730
D** 35,926 30 1,077,780
38,043,510

Compiled By CA Santosh Adhikari

 Fixed costs 33,400,000
Net Profit 4,643,510
* Own production
** Purchases from the other manufacturer

(iv) The production and purchasing plan should be opted for the following reasons:
• It will increase the total profitability of the company.
• It will help in meeting soaring market demand, and thereby maintaining the
goodwill of the product and the company as well.

Compiled By CA Santosh Adhikari

22. Lumbini Rubber Industries Ltd. produces two types of tyres; namely, Special and Premium from
one of its factory located at Butwal. The company is very keen to adopt new technology in
accounting, and is currently following the activity based costing system. The following estimated
production, revenue and cost information from the company's activity based costing system of
Butwal factory is available for next financial year:

a. The factory will produce and sell 4,000 units of Special tyre and 5,000 units of Premium tyre.
The selling price will be Rs. 12,500 per unit and Rs. 20,000 per unit for Special tyre and
Premium tyre respectively.

b. The direct materials and direct manufacturing labour costs will be Rs. 7,500 per unit and Rs.
10,500 per unit for Special tyre and Premium tyre respectively.

c. The factory has separate plant for production of each product line. The total book value of the
plants will be Rs. 10,000,000 at the beginning of the next financial year with a one-year useful
life and zero disposal value. Any plant not used will remain idle. The plants can be
distinguished between the product lines in the proportion of 42:58.

d. The factory incurs both fixed and variable type of marketing and distribution costs. The fixed
cost portion is Rs. 10,000,000 and can be allocated between the product lines in the ratio of
40:60. This fixed cost of a product line can be avoided if the line is discontinued. Besides, the
variable part is based on number of shipment of each type of tyres at the rate of Rs. 75,000 per
shipment. It is estimated that the product will be distributed in 40 shipments and 100 shipments
respectively for Special tyre and Premium tyre.

e. Fixed general administration cost of Rs. 33,000,000 and Corporate office cost of Rs.
15,000,000 are allocated to the product lines on the basis of their respective revenue.
These costs will not change if sales of individual product lines are increased or decreased or if
product lines are added or dropped.

Required:
i) Prepare an Income Statement of Butwal factory of the company showing operating income or
loss of each product line separately and in total.

ii) If, from the statement in (a) above, any product line shows higher loss, should Butwal factory
discontinue the product line for the year, assuming the released facilities remain idle? Show
your calculations based on financial consideration alone and explain the relevant or irrelevant
items.

iii)Calculate, with explanation of costs, the effect on the factory's operating income considering
that it will sell 4,000 more "Special tyre"? Assume that, to sell the additional quantity, the

Compiled By CA Santosh Adhikari

 factory would have to acquire additional equipment costing Rs. 4,200,000 with a one-year
useful life and zero terminal disposal value. Assume further that the fixed marketing and
distribution costs would not change but that the number of shipments would double.

iv) Given the expected performance of Butwal factory, should the company shut it down for the
year? Assume that shutting down the factory will have no effect on corporate office costs but
will lead to savings of all general administration costs of the factory. Support your
recommendation with proper calculations.

v) Suppose the company has the opportunity to open another factory at Dang, whose revenues
and costs are expected to be identical to Butwal factory's revenues and costs (including a cost
of Rs. 10,000,000 to acquire equipment with a one-year useful life and zero terminal disposal
value). Opening the new factory will have no effect on corporate office costs. Should the
company open factory at Dang? Show your calculations.

Answer
i) Estimated Income Statement of Butwal Factory for next financial year
Particulars Special Premium Total (Rs.)
Tyres (Rs.) Tyres (Rs.)
Revenue 50,000,000 100,000,000 150,000,000
{(Rs. 12,500×4,000); (Rs. 20,000×5,000)}
Costs:
Variable direct material and labour cost {(Rs. 30,000,000 52,500,000 82,500,000
7,500×4,000); (Rs. 10,500×5,000)}
Depreciation (WN 1) 4,200,000 5,800,000 10,000,000
Marketing and distribution cost (Rs.) Fixed
4,000,000 6,000,000 10,000,000
Variable{(Rs. 75,000×40); (Rs. 75,000×100)} 3,000,000 7,500,000 10,500,000
Fixed general administration costs (allocated
on the basis of revenue) 11,000,000 22,000,000 33,000,000
Corporate office costs (allocated on the basis
of revenue) 5,000,000 10,000,000 15,000,000
Total costs 57,200,000 103,800,000 161,000,000
Operating income (loss) (7,200,000) (3,800,000) (11,000,000)

WN 1) Calculation of depreciation
Since the plants have a one-year useful life and zero disposal value, their book value of Rs.
10,000,000 at the beginning of the financial year shall be fully depreciated. The depreciation
shall be allocated to the product line on the proportion of their respective book value; i.e. 42:58.

Compiled By CA Santosh Adhikari

 ii) Decision on discontinuation of the product line with higher loss
As seen in (a) above, the product line "Special Tyre" will have higher loss than "Premium
Tyre". The decision on discontinuation can be taken by comparing the loss in revenue with
saving in costs as below:

Particulars Amount (Rs.)

Incremental Revenue lost (Rs.) (50,000,000)
Incremental saving in costs:
Variable direct material and labour costs 30,000,000
Marketing and distribution costs (all avoidable) 7,000,000
Total incremental saving in costs 37,000,000
Incremental operating income/ (loss) (13,000,000)

Explanation on relevant and irrelevant items:

By dropping the "Special Tyre" product line, Butwal Factory will save none of the depreciation
on equipment, general administration costs, and corporate office costs, but it will save variable
manufacturing costs and all marketing and distribution costs.

Analysis and decision:

Dropping the "Special Tyre" product line will result in revenue losses of Rs. 50,000,000 and
cost savings of Rs. 37,000,000. Hence, Butwal Factory's operating income will be Rs.
13,000,000 lower, if it drops this product line. Therefore, Butwal Factory should not
discontinue the "Special Tyre" product line.

iii) Effect on the factory's operating income considering that it will sell 4,000 more "Special tyre"

Particulars Amount (Rs.)

Incremental Revenue (Rs. 12,500×4,000) 50,000,000
Incremental Costs:
Variable direct material and labour cost 30,000,000
(Rs. 7,500×4,000)
Writing off the cost of additional equipment 4,200,000
Marketing and distribution cost (for additional shipment)
Variable (Rs. 75,000×40) 3,000,000
Total incremental costs 37,200,000
Incremental operating income 12,800,000

Explanation on relevant and irrelevant items:

The additional costs of equipment written off as depreciation are relevant future costs for
selling more "Special Tyre" decision, because they represent incremental future costs that differ

Compiled By CA Santosh Adhikari

 between the alternatives of selling and not selling additional "Special Tyre". General
administration and corporate office costs will be unaffected if Butwal Factory decides to sell
more "Special Tyre". Hence, these costs are irrelevant for the decision.

Analysis and decision:

Selling 4000 more "Special Tyre" will result in incremental operating income of Rs.
12,800,000. Therefore, Butwal Factory should try to sell additional "Special Tyre" product.

iv) Decision on shutting down Butwal Factory

Statement showing relevant costs and relevant revenue of shutting down the Factory

Particulars Total (Rs.)

Incremental Revenue loss (As in (a) above) (150,000,000)
Incremental savings in costs:
Variable direct material and labour cost (As in (a) above) 82,500,000
Depreciation 0
Marketing and distribution cost (As in (a) above) 20,500,000
Fixed general administration costs 33,000,000
Corporate office costs 0
Total incremental saving in costs 136,000,000
Operating income/ (loss) (14,000,000)

Analysis and decision:

The company will save variable manufacturing costs, marketing and distribution costs, and
factory general administration costs by closing the Butwal Factory but equipment-related
depreciation and corporate office allocations are irrelevant to the decision. Equipmentrelated
costs are irrelevant because they are past costs (and the equipment has zero disposal price).
Corporate office costs are irrelevant because the company will not save any actual corporate
office costs by closing the factory. The corporate office costs that used to be allocated to the
factory will be allocated to other factory.
As the above calculations show, the company's operating income would decrease by Rs.
14,000,000 if it shuts down the Butwal Factory. Therefore, it is not recommended to shut down
the Butwal Factory.

v) Decision on opening Dang Factory

Statement showing relevant costs and relevant revenue of opening the Factory
Particulars Total (Rs.)
Incremental Revenue (As in (a) above) 150,000,000
Incremental costs:
Variable direct material and labour cost (As in (a) above) (82,500,000)

Compiled By CA Santosh Adhikari

 Depreciation (equipment used for this factory written off) (10,000,000)
Marketing and distribution cost (As in (a) above) (20,500,000)
Fixed general administration costs (33,000,000)
Corporate office costs 0
Total incremental costs (146,000,000)
Operating income/ (loss) 4,000,000

Analysis and decision:

The relevant costs include direct materials, direct manufacturing labor, marketing and
distribution, equipment, and division general administration costs but not corporate office
costs. The cost of equipment written off as depreciation is relevant because it is an expected
future cost that the company will incur only if it opens the Dang Factory. Corporate office costs
are irrelevant because actual corporate office costs will not change if the company opens the
new factory. The company will allocate some corporate office costs to the factory but this
allocation represents corporate office costs that are currently being allocated to some other
factory.
The company should open the Dang Factory because it would increase operating income by
Rs. 4,000,000.

Compiled By CA Santosh Adhikari