Ashish Sir Notes - 2 - Final

Measuring Profitability
Compiled by Aashish B Chandak

Measuring Efficiency
Example on Profitability Ratios
Issues surrounding the use of financial performance indicators to

monitor performance.

Illustration – Problems of financial performance indicators
Non-financial performance indicators (NFPIs)

The Balanced Scorecard
Q.1

Return on Investment (ROI)

Q.2 ROI Calculation

Evaluation of ROI as a performance measure

Q.3 Disadvantages of ROI
Residual Income

Residual Income Calculation
ROI Vs RI

Transfer Pricing

Setting the transfer price

Full Cost and Marginal Cost

Q.3
Q.4 Maximum Transfer Price

Q.5
XYZ Ltd which has a system of assessment of Divisional Performance on the basis of residual
income has two Divisions, Alfa and Beta. Alfa has annual capacity to manufacture 15,00,000
numbers of a special component that it sells to outside customers, but has idle capacity. The
budgeted residual income of Beta is ` 1,20,00,000 while that of Alfa is ` 1,00,00,000. Other
relevant details extracted from the budget of Alfa for the current years were as follows:
Particulars
Sale (outside customers) 12,00,000 units @ ` 180 per unit
Variable cost per unit ` 160
Divisional fixed cost ` 80,00,000
Capital employed ` 7,50,00,000
Cost of Capital 12%
Beta has just received a special order for which it requires components similar to the ones
made by Alfa. Fully aware of the idle capacity of Alfa, beta has asked Alfa to quote for
manufacture and supply of 3,00,000 numbers of the components with a slight modification
during final processing. Alfa and Beta agree that this will involve an extra variable cost of ` 5
per unit.
You are required to calculate,
The transfer price which Alfa should quote to Beta to achieve its budgeted residual income.
Q.6
A company fixes the inter-divisional transfer prices for its products on the basis of cost plus an
estimated return on investment in its divisions. The relevant portion of the budget for the
Division X for the year 2015 -16 is given below:
Particulars Amount in (`)
Fixed Assets 5,00,000
Current Assets (other than debtors) 3,00,000
Debtors 2,00,000
Annual fixed cost for the division 8,00,000
Variable cost per unit of product 10
Budgeted volume of production per year (units) 4,00,000

Desired Return on Investment 28%
Q.7

Make Vs Buy: Other Issues to Consider
Outsourcing Pros and Cons

Q.8
Division A is a profit centre that produces three products X, Y and Z and each product has an
external market.
The relevant data is as:
X Y Z
External market 48 46 40
price per unit (`)
Variable cost of 33 24 28
production
(division A) (`)
Labour hours per 3 4 2
unit (division A)
Maximum external 800 500 300
sales units
Up to 300 units of Y can be transferred to an internal division B.
Division B has also the option of purchasing externally at a price of ` 45 per unit.
Determine the transfer price for Y the total labour hours available in division A is:
(a) 3800 hours
(b) 5600 hours
Q.9
A market gardener is planning his production for next season and he asked you, as a cost
consultant, to recommend the optimum mix of vegetable production for the coming year. He
has given you the following data relating to the current year:
POTATOES TOMATOES PEAS CARROTS
Area occupied 25 20 30 25
in acres
Yield per acre in 10 8 90 12

tons
Selling Price per 1,000 1,250 1,500 1,350

ton (`)
Variable Cost per acre:
Fertilizer 300 250 450 400
Seeds 150 200 300 250

Pesticides 250 150 200 250
Direct Wages 4,000 4,500 5,000 5,700
Fixed Overhead per annum: `5,40,000
The land which is being used for the production of carrots and peas can be used for either crop
but not for potatoes and tomatoes. The land being used for potatoes and tomatoes can be used
for either crops but not carrots and peas. In order to provide an adequate market service, the
gardener must produce each year at least 40 tons of each of potatoes and tomatoes and 36
tons of each peas and carrots .You are required to present a statement to show :
(a) (1) The profit for the current year:
(2) The profit for the production mix you would recommend;
(b) Assuming that the land could be cultivated in such a way that any of the above crops could
be produced and there was no market commitment. You are required to:
(1) Advice the market gardener on which crop he should concentrate his production.
(2) Calculate the profit if he were to do so, and
(3) Calculate in rupees the breakeven - point of sales.
Q.10
A mobile manufacturing company finds that while it costs ` 6.25 each to make a component
X – 2370, the same is available in the market at ` 5.75 with an assurance of continued supply.
The break-down of cost is:
Direct materials ` 2.75 each
Direct labour ` 1.75 each
Other variables ` 0.50 each
Depreciation and other fixed cost ` 1.25 each
Total ` 6.25 each
(a) Should you make or buy?
(b) What would be your decision if the supplier offers the component at ` 4.85 each?


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Measuring Profitability

Compiled by Aashish B Chandak

Example on Profitability Ratios

Issues surrounding the use of financial performance indicators to

Compiled by Aashish B Chandak

Non-financial performance indicators (NFPIs)

Compiled by Aashish B Chandak

Compiled by Aashish B Chandak

Compiled by Aashish B Chandak

Compiled by Aashish B Chandak

Compiled by Aashish B Chandak

Compiled by Aashish B Chandak

Compiled by Aashish B Chandak

Compiled by Aashish B Chandak

Compiled by Aashish B Chandak

Compiled by Aashish B Chandak

Q.4 Maximum Transfer Price

Compiled by Aashish B Chandak

Sale (outside customers) 12,00,000 units @ ` 180 per unit

Variable cost per unit ` 160

Divisional fixed cost ` 80,00,000

Capital employed ` 7,50,00,000

Cost of Capital 12%

Particulars Amount in (`)

Fixed Assets 5,00,000

Current Assets (other than debtors) 3,00,000

Annual fixed cost for the division 8,00,000

Variable cost per unit of product 10

Budgeted volume of production per year (units) 4,00,000

Compiled by Aashish B Chandak

Compiled by Aashish B Chandak

Outsourcing Pros and Cons

Compiled by Aashish B Chandak

Up to 300 units of Y can be transferred to an internal division B.

(a) 3800 hours

(b) 5600 hours

Yield per acre in 10 8 90 12

Selling Price per 1,000 1,250 1,500 1,350

Variable Cost per acre:

Fertilizer 300 250 450 400

Seeds 150 200 300 250

Compiled by Aashish B Chandak

Direct Wages 4,000 4,500 5,000 5,700

Fixed Overhead per annum: `5,40,000

(a) (1) The profit for the current year:

(2) Calculate the profit if he were to do so, and

(3) Calculate in rupees the breakeven - point of sales.

Direct labour ` 1.75 each

Other variables ` 0.50 each

Depreciation and other fixed cost ` 1.25 each

Total ` 6.25 each

(a) Should you make or buy?

Compiled by Aashish B Chandak

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