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Cost Academy
Advanced Management Accounting
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Cost Academy
Some additional very important problems &

solutions which are not in the study material
of ICAI.
Cost Academy
Content
Page No.
1. Problem on Transfer Pricing004

2. Problem Marginal Costing006
3. Activity Based Costing. 007
3. JIT & MRP 022
4. Total Quality management026
5. Value chain & cost reduction 028
6. Target costing 031
7. Life cycle costing033
8. Shutdown & divestment035
9. Relevant costing & decision making 039
10.Budget & budgetary control 055
11. Standard Costing062
12.Learning Curve063
Cost Academy
Problem on Transfer pricing

1.
The PillerCat corporation is a highly decentralized company. Each division manager has full
authority for sourcing decisions and selling decisions. The Machining division of Pillercat has
been the major supplier of the 2,000 crankshafts that the Tractor Division needs each year.
The tractor division, however, has just announced that it plans to purchase all its crankshafts in
the forthcoming year from two external suppliers at Rs. 200 per crankshaft. The Machining
Division of Pillercat recently increased its selling price for the forthcoming year to Rs. 220 per unit
(from Rs. 200 per unit in the current year).
Juan Gomez, manager of the Machining division, feels that the 10% price increase is justified. It
results from a higher depreciation charge on some new specialized equipment used to
manufacture crankshafts and an increase in labour costs. Gomez wants the president of Pillercat
Corporation to force the Tractor Division to buy all its crankshafts from the machining Division at
the price of Rs. 220. The following table summarizes the key data.
A
B
1.
Number of crankshafts purchased by Tractor division
2,000
2.
External suppliers market price per crankshaft
Rs. 200
3.
Variable cost per crankshaft in Machining Division
Rs. 190
4.
Fixed cost per crankshaft in Machining Division
Rs. 20
Required:
1.
Compute the advantage or disadvantage in terms of annual operating income to the
Pillercat corporation as a whole if the Tractor Division buys crankshafts internally from the
Machining division under each of the following cases:
(a) The Machining Division has no alternative use for the facilities used to manufacture
crankshafts.
2.
(b)
The machining division can use the facilities for other production operations, which will
result in annual cash operating savings of Rs. 29,000.
(c)
The Machining Division has no alternative use for its facilities, and the external
supplier drops the price to Rs. 185 per crankshaft.
As the president of Pillercat, how would you respond to Juan Gomezs request that you
force the Tractor Division to purchase all of its crankshafts from the Machining Division?
Would you response differ according to the three cases described in requirement 1?
Explain.
Solution
1.
Computations for the Tractor Division buying crankshafts internally for one year under cases a, b
and c are:
Case
Number of crankshafts purchased by
Tractor Division
2,000
2,000
2,000
200
200
185
Incremental cost per crankshaft in Machining Div. (Rs.) 190
190
190
Rs. 29,000
--
External suppliers market price per crankshaft (Rs.)
Opportunity costs of the machining division supplying

Crankshafts to the Tractor Division
--
Cost Academy
Total purchase costs if buying from an external Supplier

(2,000 shafts Rs. 200,
Rs. 200, Rs. 185 per shaft) (Rs.)
4,00,000
4,00,000
3,70,000
Incremental costs of buying from the Machining

Div. (2,000 shafts Rs. 190 per shaft)
3,80,000
3,80,000
3,80,000
_______-3,80,000
29,000
4,09,000
_______-3,80,000
20,000
(9,000)
(10,000)
Total opportunity costs of the Machining Div.

Total relevant costs
Annual operating income advantage
(disadvantage) to Pillercat of buying from the
Machining Division (Rs.)
The general guideline that was introduce as a first step in setting a transfer price can be used to
highlight the alternatives:
Case
incremental cost
opportunity cost
External
Per unit incurred to
per unit to the
transfer
market
Point of transfer
+
supplying div. =
price
Price
a
b
c
Rs. 190
Rs. 190
Rs. 190
+
+
+
Rs. 0
Rs. 14.50
Rs. 0
=
Rs. 190
= Rs. 204.50
=
Rs. 190
Rs. 200
Rs. 200
Rs. 185
Opportunity cost = Total opportunity cost No. of crankshafts = Rs. 29,000 2,000 = Rs. 14.50
Per unit.
Comparing transfer price to external-market price, the Tractor Division will maximize annual
operating income of Pillercat Corporation as a whole by purchasing from the Machining Division
in case a and by purchasing from the external supplier in case of b and c.
Cost Academy
On Marginal costing
1.
Wembley Travel Agency specializes in flights between Los Angeles and London. It books
passengers on United Airlines at Rs. 900 per round-trip ticket. Until last month, united paid
Wembley a commission of 105 of the ticket price paid by each passenger. This commission was
Wembleys only source of revenues. Wembleys fixed costs are Rs. 14,000 per month (for
salaries, rent, and so on), and its variable costs are Rs. 20 per ticket purchased for a passenger.
This Rs. 20 includes a Rs. 15 per ticket delivery fee paid to Federal Express. (To keep the
analysis simple, we assume each round-trip ticket purchased is delivered in a separate package.
Thus, the Rs. 15 delivery fee applies to each ticket).
Required:
1. Under the old 10% commission structure, how many round-trip tickets must Wembley sell
each month (a) to break even and (b) to earn an operating income of Rs. 7,000?
2. How does Uniteds revised payment schedule affect yours answers to (a) and (b) in
requirement 1?
Solution
1.
Wembley receives a 10% commission on each ticket: 10% Rs. 900 = Rs. 90 thus
Selling price
= Rs. 90 per ticket
Variable cost per unit
= Rs. 20 per ticket
Contribution margin p.u.
= Rs. 90- Rs. 20 = Rs. 70 per ticket
Fixed costs
= Rs. 14,000 per month
a. Break even number of tickets = Fixed costs Contribution margin per unit
= Rs. 14,000 Rs. 70 per ticket
= 200 tickets
b. When target operating income = Rs. 7,000 per month:
Qty. of tickets required
to be sold
= (Fixed costs + Target operating income)Contribution margin
per unit.
= (Rs. 14,000+Rs. 7,000)Rs. 70 per ticket
= Rs. 21,000 Rs. 70 per ticket
= 300 tickets
2.
Under the new system, Wembley would receive only Rs. 50 on the Rs. 900 ticket. Thus,
Selling price
= Rs. 50 per ticket
Variable cost p. u.
= Rs. 20 per ticket
Contribution margin p. u.
= Rs. 50 Rs. 20 per ticket
Fixed costs
= Rs. 14,000 per month
a. Breakeven number of tickets
= Rs. 21,000Rs. 30 per tickets = 700 tickets
required to be sold
The Rs. 50 cap on the commission paid per ticket causes the breakeven point to more than
double (from 200 to 467 tickets) and the tickets required to be sold to earn Rs. 7,000 per month
to also more than double 9from 300 to 700 tickets). As would be expected, travel agents reacted
very negatively to the United Airlines decisions to change commission payments. Unfortunately
for travel agents, other airlines also changed their commission structures in similar ways.
Cost Academy
On Activity Base Costing

1.
The following information provides details of costs, volume & cost drivers for a particulars period
in respect of ABC Ltd. for product X, Y and Z.
1. production & sales (units)
2. Raw material usage (units)
3. Direct material cost (Rs.)
4. Direct labour hours
5. Machine hours
6.
7.
8.
9.
10.
11.
Direct labour cost (Rs.)

No. of production runs
No. of deliveries
No. of receipts (27)*
No. of production orders
Overhead costs:
Set-up
Machines
Receiving
Packing
Engineering
Product X
30,000
5
25
1
1
3
1
1
3
8
3
9
15
15
product Y
20,000
5
20
Product Z
8,000
11
11
Total
12,38,000
88,000
76,000
12
7
3
35
10
6
20
20
220
25
30
32
270
50
30,000
7,60,000
4,35,000
2,50,000
3,73,000
Rs. 18,48,000
* The company operates a just-in-time inventory policy, and receives each component once per
production run. In the past the company has allocated overheads to products on the basis of
direct labour hours. However, the majority of overheads are related to machine hours rather than
direct labour hours. The company has recently redesigned its cost system by recovering
overheads using two volume related bases: machine hours and a materials handling overhead
rate for recovering overheads of the receiving department. Both the current and the previous cost
system reported low profit margins for product X, which is the companys highest-selling product.
The management accountant has recently attended a conference on activity-based costing, and
the overhead costs for the last period have been analyzed by the major activities in order to
compute activity based costs.
From the above information you are required to:
(a) Compute the product costs using a traditional volume-related costing system based on
The assumption that:
(i) All overheads are recovered on the basis of direct labour hours (i.e. the companys past
product costing system);
(ii)
The overheads of the receiving department are recovered by a materials handling

overhead rate and the remaining overheads are recovered using a machine hour rate
(i.e., the company current costing system).
(b) Compute product costs using an activity-based costing system.
Cost Academy
Solution
(a)
Computation of the product cost using a traditional volume related costing system based
on assumption that:
(i) All overheads are recovered on the basis of direct labour hours (i.e., the company product
Costing system)
Statement showing the product cost
X
Y
Rs.
Rs.
Direct labour
8
12
Direct materials
25
20
Overheads
28
42
1
2hrs.xRs.21
1 hrs.xRs.21
(Refer to working note)
3
_______
______
Total
61
74
Products
Z
Rs.
6
11
21
1hr.xRs.21
______
38
Working note:
Overheads to be charged to products
Total overheads
Direct labour overhead rate =Total
---------------------------------direct labour hours
=
Rs.18,48,000
Rs.88,000hrs.
= Rs. 21 per direct labour hour.

(ii) The overheads of the receiving department are recovered by material handling overhead rate
& the remaining overheads are recovered by using a machine hour rate (i.e. the company
current costing system)
Products
Direct labour
Direct materials
Material handling overhead
(Ref. To working note)
other overheads
(Machine hour basis)
(1
Total cost
X
Rs.
8
25
8.78
Y
Rs.
12
20
7.03
Z
Rs.
6
11
3.87
(Rs. 2535.14%)
(Rs. 2035.14%)
(Rs. 1135.14%)
24.79
18.59
37.18
1
hrs.Rs. 18.59)
3
---------66.57
(1hr.Rs. 18.59)
(2 hrs.Rs. 18.59)
---------57.62
-----------58.05
Working note: Overheads to be charged to products:

Receiving department overheads
Material handling overhead rate
= -----------------------------------------------------Direct material cost
=
Rs.4,35,000
x100
Rs.12,38,000
cost.
Machine hour overhead rate
Other overheads
= ---------------------------------Machine hours
= 35.14% of direct material
Cost Academy

=
(b)
Rs.14,13,000
= 18.59 per machine hours.
76,000hrs.
Statement showing the product costs using an activity based costing system.
Products
X
Rs.
8
25
13.33
Direct labour
Direct material
Machine overheads
(Refer to working note 1)
(1
Set-up costs
Y
Rs.
12
20
10
Z
Rs.
6
11
20
1
hrs.Rs. 10) (1 hr.Rs. 10) (2 hr.Rs. 10)
3
0.10
0.35
2.50
Rs.1,000 x3 Rs.1,000 x 7 Rs.1,000 x 20
30,000
20,000
8,000
(Ref. To working note 2 (i))

Receiving
0.81
2.82
44.36
Rs.1,611x15 Rs.1,611x35 Rs.1,611x 200
30,000
20,000
8,000
(Ref. To working note 2(ii))

Packing
2.34
1.17
19.53
Rs.7,812 x9 Rs.7,812 x3 Rs.7,812 x 20
30,000
20,000
8,000
(Ref. To working note 2 (iii))

Engineering
3.73
3.73
23.31
Rs.7,460 x15 Rs.7,460 x10 Rs.7,460 x 25
30,000
20,000
8,000
(Ref. To working note 2 (iv))
----------53.31
Total manufacturing cost
----------50.07
--------126.64
Working note:
1. Machine overhead rate per hour
Rs.7,60,000
= Rs. 10
76,000hrs
2. The cost per transaction or activity for each of the cost Centres is as follows:
(i) Set-up cost
Setup cost (Rs. 30,000)
Cost per setup = ---------------------------------------------Number of production runs (30) = Rs. 1,000
(ii) Receiving cost
Receiving cost (Rs. 4,35,000)
Cost pre receiving order = ----------------------------------------------= Rs. 1,611
No. of orders (270)
(iii) Packing Cost
Packing cost (Rs. 2,50,000)
Cost per packing order = ------------------------------------------------Rs. 7,812
Number of orders (32)
(iv) Engineering
Engineering cost (Rs. 3,73,000)
Cost per production order = No.
--------------------------------------------= Rs. 7,460
of production order (50)
2.
Apollo plc manufactures and sells several products, two of which are Alpha and Beta. Estimated
data. For the two products for the forthcoming period is as follows:
(i)
Product data
Production/sales units
Total direct material cost
Total direct labour cost
Alpha
Beta
5,000
Rs.000
80
40
10,000
Rs.000
300
100
40,000
Rs.000
2,020
660
Cost Academy
10
(ii)
Variable overhead cost is Rs.1,500,000 of which 40 percent is related to the acquisition,

storage and use of direct materials and the remainder is related to the control and use of
direct labour.
(iii)
It is current practice for Apollo plc to absorb the two types of variable overhead cost to
products using an overall company-wide percentage based on either direct material cost
and direct labour cost as appropriate.
(iv)
Apollo are considering the use of activity-based costing. The cost drivers for material and
labour related overheads have been identified as follows:
Alpha
Beta
other Product
1.5
Direct labour related

Overheads-cost drivers is
Number of labour operations
Labour operations/unit
6
Direct material related

Overheads-cost driver is
Weight of material
Weight of material/unit
(v)
Market investigation indicates that markets prices for Alpha and Beta of 75 and 95 per unit
Respectively will achieve the estimated sales shown in (i) above.
(vi)
Apollo plc require a minimum estimated contribution: sales ration of 40 percent before
proceeding with the production or sale of any product.
Requirements
(a)
Prepare estimated unit product costs for Alpha and beta where the variable overhead is
charged to product units as follows:
(i) Using the existing absorption rates as detailed above,
(ii) Using an activity-based costing approach.
(b)
Using the information in (a) prepare an analysis that will help Apollo determine whether
both A and B should remain in production.
Your answer should include relevant calculations and discussion and be prepared in a form
suitable for presentation to management.
(c)
Explain how Apollo could make use of target costing in conjunction with activity-based
costing with respect to Alpha and Beta.
Solution
(a) (i) Unit costs using traditional absorption costing
Material related overhead cost (40% of Rs. 1.5m) = Rs.600,000
Overhead absorption rate {(Rs.600,000 Rs.2,400,000)x 100} = 25% of direct material cost
Labour related overhead cost (60% of Rs.1.5m) = Rs.900,000
Overhead absorption rate {(Rs.900,000 Rs. 800,000) x 100} = 112.5% of direct labour cost
Cost Academy
Alpha
Rs.
Direct materials
16
Direct labour
__8
Prime cost
24
Material related overhead (25%)
4
Labour related overheads (112.5%)9
Total variable costs
37
(iii)
11
Beta
Rs.
30
__10
40
7.5
11.25
58.75
Unit costs based on activity-based costing

Alpha
Production units
5,000
Weight of direct material (kg)
4
Total weight of material (kg) 20,000
Mat. Related overhead/kg
Alpha
5,000
6
30,000
Lab. Related overheads/op
Direct materials
Direct labour
Prime cost
Material overhead
Labour related overheads
Other
40,000
1.5
60,000
Rs. 600,000_____________ = Rs. 6.67/kg

20,000+10,000+60,000
Production units
Labour operations/unit
Total operations
Unit costs based on ABC
Beta
10,000
1
10,000
Beta
10,000
1
10,000
Rs. 900,000
Rs. 30,000+10,000+80,000
Alpha
Rs.
16
___8
24
26.68
45
95.68
Others
40,000
2
80,000
= Rs. 7.5 per op.
Beta
Rs.
30
___10
40
6.67
7.5
54.17
(b)
Alpha
Direct material
Direct labour
Material overhead
Labour related overhead
Total variable cost
Selling price
Contribution/unit
C/S ration
Traditional
Rs.
16
8
4
____9
37
75.00
38
51%
ABC
Rs.
16
8
26.68
___45
95.68
75.00
(20.68)
(28)%
Beta
Traditional
Rs.
30
10
7.50
11.25
58.75
95.00
36.25
38%
ABC
Rs.
30
10
6.67
7.50
54.17
95.00
40.83
43%
Apollo plc require a minimum C/S ratio of 40 per cent. If product costs are determined using the
traditional methods Apollo would decide to proceed with the production of Alpha (C/S ratio of 51
per cent) and reject Beta which has a C/S just below the required 40 per cent.
If ABC is used the decision will be reversed. Alpha will be rejected on the basis of a negative C/S
ratio and Apollo will proceed with Beta, which has a C/S ratio of 43 per cent.
ABC Provides a more accurate cost of products unlike the traditional methods used, which is a
broad-based averaging of costs. ABC attempts to reflect the true consumption of resources.
Cost Academy
12
(c)
The use of target costing in conjunction with ABC will enable Apollo to find ways of reducing the
costs of Alpha to arrive at a target cost. Cost reduction methods such as value analysis and
value engineering could be used to achieve this. Though Beta just meets the required 40 per
cent C/S ratio, Apollo could decide to increase margins further by carrying out a similar exercise
on Beta. Target costing should also be used to identify selling prices for specific markets.
3.
Trimake Ltd makes three main products, using broadly the same production methods and
equipment for each. A conventional product costing system is used at present, although an
activity-based costing (ABC) system is being considered. Details of the three products for a
typical period are:
Product x
Product Y
Product Z
Hours per unit

Labour
Machine
Hours
hours
0.5
1.5
1.5
1
1
3
Material
per unit
Rs.
20
12
25
Volume
units
750
1,250
7,000
Direct labour costs Rs.6 per hour and production overheads are absorbed on a machine hour
basis. The rate for the period is Rs.28 per machine hour.
Requirements
(a) Calculated the cost per unit for each product using conventional methods
Further analysis shows that the total of production over heads can be divided as follows:
%
35
20
15
30
100
Costs relating to set-up

Costs relating to machinery
Costs relating to material handling
Costs relating to inspection
Total production overhead
The following total activity volumes are associated with the product line for the period as a whole:
Product X
Product Y
Product Z
Number of
Set-ups
75
115
480
670
Movements
of materials
12
21
87
120
Number of
inspections
150
180
670
1,000
(b) Calculate the cost per unit for each product using ABC principles.
(c) Comment on the reasons for any differences in the costs in your answers to (a) and (b).
Solution
(a)
Conventional cost per unit
Materials
Labour
Direct cost
Production overheads (Rs.28/hour)
Total production cost per unit
X
Rs.
20
__3
23
42
65
Y
Rs.
12
__9
21
28
49
Z
Rs.
25
__6
31
84
115
Cost Academy
(b)
13
ABC cost per unit

Analysis of total overheads and cost per unit of activity
%
Total
Level
Cost per unit
Overhead of activity of activity
Rs.
Rs.
Set-ups
35
229,075
670
341.90
Machining
20
130,900
23,375
5.6
Materials movement
15
98,175
120
818.13
Inspection
30
196,350
1,000
196.35
100
654,500 *
Working
*Total overheads
Production
Machine hours Total
OAR
Total
Units
per unit
Machine hours
overheads
X
750
1.5
1,125
Rs.28 Rs.31,500
Y
1,250
1.0
1,250
Rs.28 Rs.35,000
Z7,000
3.0
21,000
Rs.28
Rs.588,000
23,375
Rs.654,500
Total overheads by product and per unit
Overhead
X
Activity
Set-ups
Machining
Mat. Movement
Inspection
75
1,125
12
150
Total overheads
No. of units
Overhead cost per unit
Y
Activity
Cost
Cost
Activity
Rs.
Rs.
25,643 115
39,319
480
6,300 1,250
7,000 21,000
9,817
21
17,181
87
29,453 180
35,343
670
_______
________
71,213
98,843
750
1,250
Rs.94.95
Rs.79.07
Z
Cost
Total
Rs.
229,075
130,900
98,175
196,350
_______
654,500
164,113
117,600
71,177
131,554
_______
484,444
7,000
Rs.69.21
Total cost per unit

Direct costs
Overhead costs
Total production cost
Per unit
(c)
Comment
Product
Overheads per unit
(Conventional system)
Overheads per unit
(activity-based costing)
X
Rs.
23.00
94.95
117.95
Y
Rs.
21.00
79.07
100.07
Z
Rs.
31.00
69.21
100.21
X
Rs.
42.00
Y
Rs.
28.00
Z
Rs.
84.00
94.95
79.07
69.21
A change to activity-based costing results in the overhead costs of X and Y increasing while the
overhead cost of Z decreases.
The adoption of ABC provides a fairer unit cost that better reflects the effort required in the
manufacture of different products.
This can be illustrated with Z, a major product line which takes longer to produce but once
production has begun is simple to administer unlike X and Y which are minor products but still
require a fair amount of administrative time. See table below :
Cost Academy
Activities per 1000 units
Set-ups
X
Y
Z
100
92
69
Material
Movement
16
17
12
14
Inspections
200
144
96
This highlights:
Product Z has fewer set-ups, material movements and inspections per 1,000 units that X
or Y.
As a consequence product Zs overhead cost per unit for these three activities has fallen.
The machine overhead cost per unit is still two to three times greater than X and Y.
4.
Having attended a ICAI course on activity-based costing (ABC) you decide to experiment by
applying the principles of ABC to the four products currently made and sold by your company.
Details of the four products and relevant information are given below for one period :
Product
Output in units
Cost per unit ;
Direct material
Direct labour
Machine hours (per unit)
A
120
Rs.
40
28
4
B
100
Rs.
50
21
3
C
80
Rs.
30
14
2
D
120
Rs.
60
21
3
The four products are similar and are usually produced in production runs of 20 units are sold in
batches of 10 units.
The production overhead is currently absorbed by using a machine hour rate, and the total of the
production overhead for the period has been analyzed as follows:
Rs.
Machine department costs
(Rent, business rates, depreciation and supervision)
Set-up costs
Stores receiving
Inspection / Quality control
Materials handling and dispatch
10,430
5,250
3,600
2,100
4,620
You have ascertain that the cost drivers to be used are as listed below for the overhead costs
shown :
Cost
Cost Driver
Set up costs
Number of production runs
Stores receiving
Requisition raised
Inspection / Quality control
Materials handling and dispatchOrders executed
The number of requisition raised on the stores was 20 for each product and the number of
orders executed was 42, each order being for a batch of 10 of a product, You are required.
(a)
to calculate the total costs for each product if all overhead costs are absorbed in a
machine hour basis;
(b)
to calculate the total costs for each product, using activity-based costing ;
(c)
to calculate and list the unit product costs from your figures in (a) and (b) above, to show
the differences and to comment briefly on any conclusions which may be drawn which
could have pricing and profit implications.
Cost Academy
15
Solution
(a)
Total machine hours = (120 4 hrs.) + (100 3 hrs) + (80 2 hrs) + (120 3 hrs.) = 1300 hrs.
Machine hour overhead rate =
Rs.10,430 + Rs.5250 + Rs.3600 + Rs.2100 + Rs.4620
1300 hours
= Rs.20 per machine hour
Product
A
Rs.
Direct material
40
Direct labour
28
Overhead at Rs.20 per machine hour 80
148
Units of output
Total cost
(b)
120
Rs.17,760
Costs
Cost driver
Rs.
Machine department 10,430
Set-up costs
5,250
Stores receiving
3,600
Inspection/ quality control2,100
Materials handling
4,620
B
Rs.
50
21
60
131
C
Rs.
30
14
40
84
D
Rs.
60
21
60
114
100
Rs.13,100
80
Rs.6,720
120
Rs.16,920
Cost driver
Transactions
Machine hours
1300 hours
Production runs
21
Requisitions raised 80
(420)
Production runs
21
Number of orders
Executed
42
Cost per
unit
Rs.
8.02
250
45
100
110
Note:
Number of production runs = Total output (420 units) 20 unit per set-up.
Number of orders executed = Total output (420 units) 10 units per order.
The total cost for each product are computed by multiplying the cost driver rate per unit by the
quantity of the cost driver consumed by each product.
Prime Costs
Set-up
Stores/ receiving
Inspection/quality
Handling dispatch
Machine dept. cost
Total Costs
A
8,160
1,500
900
600
1320
3851
16,331
(Rs.68120)
(Rs.250 6)
(Rs.4520)
(Rs.1006)
(Rs.11012)
B
C
7,100
3520
1,250 (Rs.2505) 1000
900
900
500
400
1100 (Rs.11010) 880
2407
1284
13,257
7984
D
9,720
1500
900
600
1320
2888
16,928
Note:
a
A = 120 units 4 hrs Rs.8.02; B = 100 units3 hrs Rs.8.02
(c)
Cost per unit

Costs from (a)
Cost from (b)
148.00
136.00
(11.91)
131.00
132.57
1.57
84.00
99.80
15.80
141.00
141.07
0.07
Product A is over-costed with the traditional system. Production B and C are under costed and
similar costs are reported with Product D. It is claimed that ABC more accurately measures
resources consumed by products (see Errors arising from relying on misleading product costs
in Chapter 10). Where cost-plus pricing is used, the transfer to an ABC system will result in
Cost Academy
5.
16
different product prices. If activity-based costs are used for stock valuations then stock valuation
and reported profits will differ.
The following budgeted information relates to Brunti for the forthcoming period ;
Sales and production (unit)
XYI
50
Products
YZT
40
ABW
30
Selling price (per unit)

Prime cost (per unit)
Rs.
45
32
Rs.
95
84
Rs.
73
65
Hours
2
Hours
5
Hours
4
Machine department
(Machine hours per unit)
Assembly department
(Direct labour hours per unit)
Overhead allocated and apportioned to production departments (including service cost centre
costs) were to be recovered in product costs as follows:
Machine department at Rs.1.20 per machine hours. Assembly department at Rs.0.825 per
direct labour hours.
You ascertain that the above overheads could be reanalyzed into cost pools as follows:
Cost pool
Machine services
Assembly services
Set-up costs
Order processing
Purchasing
Rs.000
357
318
26
___84
941
Cost driver
Machine hours
Direct labour hours
Set-up
156Customer order
Suppliers orders
Quality for the

period
420,000
530,000
520
32,000
11,200
You have also been provided with the following estimates for the period;
Products
XYI
YZT
ABW
Number of set-ups
120
200
200
Customers orders
8000
8000
16,000
Suppliers orders
3000
4000
4200
Required:
(a)
Prepare and present profit statements using;
(i)
conventional absorption costing ; (ii) Activity based costing;
(b)
Comment on why activity-based costing considered to present a fairer valuation of the

product cost per unit.
Solution
(a) (i) Conventional Absorption Costing Profit Statement :
XYI
YZT
(1) Sales volume (000 units)
50
40
Rs.
Rs.
(2) Selling pricing per unit
45
95
(3) Prime cost per unit
32
84
(4) Contribution per unit
13
11
(5) Total contri. is Rs.000 is (1 4) 650
440
(6) Machine department overheads a 120
240
ABW
30
Rs.
73
65
8
240
144
Cost Academy
(7) Assembly department overhead b 288.75

Profits (Rs.000s)
241.5
Total profit = Rs.388,750
99
101
17
49.5
46.5
Note:
a
XYI = 50,000 2 hrs. Rs.1.20, ; YZT= 40,000 5 hrs. Rs.1.20
b
XYI = 50,000 7 hrs. Rs.0.825 ; YZT = 40,000 3 hrs. Rs.0.825
(ii) Cost pools;
Rs.000
Machine
Service
357
Cost drivers
420,000
Cost driver
Rates
Machine
Hours
Rs.0.85
machine
Hour
Assembly
service
318
Set-up
26
530,000
direct
labour hours
Rs.0.60
direct
labour hour
Order
processing
156
520
set-ups
Rs.50 per
set-up
Purchasing
32,000
customer
orders
Rs.4.875 per
customer
order
84
11,200
suppliers
orders
Rs.7.50 per
suppliers
order
ABC Profit Statement:

Total contribution
Fewer overheads;
Machine department at Rs.0.85 per hour
Assembly at Rs.0.60 per hour
Set-up costs at Rs.50 per set-up
Order processing at Rs.4.875 per order
Purchasing at Rs.7.50 per order
Profit (Loss)
XYI
(Rs.000)
650
YZT
(Rs.000)
440
85
210
6
39
22.5
287.5
170
72
10
39
30
119
ABW
(Rs.000)
240
102
36
10
78
31.5
(17.5)
Total profit = Rs.389,000

6.
Repak Ltd. Is a warehousing and distribution company which receives products from customers,
stores the products and then re-packs them for distribution as required. There are three
customers for whom the service is provideJohn Ltd, George Ltd and Paul Ltd, The products
from all three customers are similar in nature but of varying degree of fragility. Basic budget
information has been gathered fro the year to 30 June and is shown in the following table:
John Ltd.
George Ltd.
Paul Ltd
Costs
Packing materials
(see note 1)
Labour -- basic
-- Overtime
Occupancy
Administration and management
Product Handled (Cubic metres)

30,000
45,000
25,000
(Rs.000)
1950
350
30
500
60
Note 1: Packing materials are used in re-packing each cubic meter of production for John Ltd,
George Ltd. and Paul Ltd. In the ratio 1: 2: 3 respectively. This ratio is linked to the relative
fragility of the goods for each customer.
Cost Academy
18
Additional information as been obtained in order to enable unit costs to be prepared for each of
the three customers using an activity- based costing approach. The additional information for the
year to 30 June has been estimated as follows:
(i)
Labour and overhead costs have been identified as attributable to each work centres
receipt and inspection, storage and packing as follows ;
Cost allocation proportions
Labour -- basic
-- Overtime
Occupancy
Receipt &
Inspection
%
15
50
20
40
Storage
%
10
15
Packing
%
75
35
60
10
20
50
(ii) Studies have revealed that the fragility of different goods affects the receipts and inspection time
needed for the products for each customer. Storage required is related to the average size of the
basis incoming product units from each customer. The re-packing of goods for distribution is
related to the complexity of packing required by each customer. The relevant requirements per
cubic metre of product for each customer have been evaluated as follows :
Receipt and inspection (minutes)

Storages (square metres)
Packing (minutes)
Jhon
Ltd.
5
0.3
36
George
Ltd.
9
0.3
45
Paul
Ltd.
15
0.2
60
Required;
(a) Calculate the budgeted average cost per cubic metre of packing products for each customer
for each of the following two circumstances;
Additional information has been obtained in order to enable unit costs to be prepared fro each of
the three customers using and activity-based costing approach. The additional information for the
year to 30 June has been estimated as follows:
(i)
Labour and overhead costs have been identified as attributable to each of three work
centres receipt and inspection, storage and packing as follows :
Cost allocation Proportions
Receipt &
Inspection
%
Labour -- basic
15
-- Overtime
50
Occupancy
20
40
(ii)
Storage
%
10
15
60
10
Packing
%
75
35
20
50
Studies are revealed that the fragility of different goods affect the receipts and inspection
time needed for the product for each customer. Storage required is related to the average
size of the basis incoming product units from each customer. The re-packing of goods for
distribution is related to the complexity of packaging required by each customer. The
relevant requirements per cubic metre of product for each customer have been evaluated
as follows:
Jhon
George
Paul
Ltd.
Ltd.
Ltd.
Cost Academy
Receipt and inspection (minutes)

Storage (square metres)
Packing (minutes)
5
0.3
36
9
0.3
45
19
15
0.2
60
Required
(a)
Calculate the budgeted average cost per cubic metre of packaged products for each
customer for each of the following two circumstances ;
(i)
where only the basis budget information is to be used,
(ii)
Where the additional information enables an activity- based costing approach to be

applied.
Solution
(a) (i)
The package material requirements are as follows :
John Ltd.
Gorge Ltd.
Paul Ltd.
30,000 units (30,0001)

90,000 units (45,000 2)
75,000 units (25,000 3)
195,000 units
Cost per unit of packing = Rs.1,950,000195,000 = Rs.10

Product costs per cubic metre
John Ltd.
George Ltd.
Paul Ltd.
Rs.
Rs.
Rs.
Packaging materials
10
(1 xRs.10)
20 (2 XRs.10)
30 (3 Rs.10)
Labour ad overhead a
9.40
19.40
9.40
29.40
9.40
39.40
Note: a Labour and overhead average cost per metre = Rs.940,000 / 100,000 meter
= Rs.9.40
(ii) The costs are assigned to the following activities
Receipt and
Inspection
Rs.
52,500 (15%)
Storage
Rs.
35,000 (10%)
Packing
Rs.
262,500 (75%)
15,000 (50%)
4,500 (15%)
10,500 (35%)
Occupancy
100,000 (20%)
Administration & management 24,000 (40%)
191,500
300,000 (60%)
6,000 (10%)
345,000
100,000 (20%)
30,000 (50%)
403,000
Labour: Basic
Overtime
The resource usage for each of the cost drivers is :

Receipt and inspection hour storage (m2)
John Ltd.
George Ltd.
Paul Ltd.
2,500 (30,000 5 mins.)

6,750 (45,000 9 mins.)
6,250 (25,000 15 mins.)
15,500
Packing hours
9,000 (30,000 0.3) 18,000 (30,000 36min)

13,500 (45,000 0.3) 33,750 (45,000 45 mins)
5,000 (25,000 0.2) 25,000 (25,0001hrs.)
27,500
76,750
The driver rates are:

Rs.12,355 per receipts and inspection hour (Rs.191,500 /15,500 hours)
Cost Academy
20
Rs.12,564 per m2 of materials stored (Rs.345,500 / 27,500 m2 )

Rs.5.251 per packing hours (Rs.403,000 / 76,750 hrs. )
Product cost per cubic metre
Packing materials
Receipts and inspection a
Storage cost b
Packing cost c
Jhon Ltd.
Rs.
10.00
1.03
3.77
3.15
17.95
George Ltd.
Rs.
20.00
1.85
3.77
3.94
29.56
Paul Ltd.
Rs.
30.00
3.09
2.51
5.25
40.85
Notes
a
Rs.12,355 5/60 hrs. = Rs.1.03;
Rs.12,355 9/50 hrs. = Rs.12,355 15/60 hrs. = Rs.3.09
7.
Rs.12,5640.3 m = Rs.3.77 ; Rs.12,564 X 0.2m = Rs.2.51.
Rs.5.25 36/60 hrs. = Rs.3.15; 5.25 45/60 hrs. = Rs.3.94 ; Rs.5.25 X 1 hrs.
XYZ plc. Manufactures four products, namely A, B, C and D, using the same plant and
processes. The following information relates to a production period;
Product
Volume
A
B
C
D
500
5,000
600
7,000
Material
cost
per unit
Direct
labour
per unit
Machine
time
per unit
Labour
cost
per unit
Rs.5
Rs.5
Rs.16
Rs.17
hour
hour
2 hours
1 hours
hours
hours
1 hours
1 hours
Rs.3
Rs.3
Rs.12
Rs.9
Total production overhead recorded by the cost accounting system is analysed under the
following headings:
Factory overhead applied to machine-oriented activity is Rs.37,424
Set-up costs are Rs.4,355. The cost of ordering materials is Rs.1920. Handling materialsRs.7580. Administration for spare parts -Rs.8600.
These overhead costs are absorbed by products on a machine hour rate of Rs.4.80 per hour,
giving an overhead cost per product of .
A = Rs.1.20
B = Rs.1.20
C = Rs.4.80 D = Rs.7.20
However, investigation into the production overhead activities for the period reveals the following
totals;
Number
of
Number
times
Number
Number
of
materials
of
of
materials
was
spare
Product
set-up
orders
handled
parts
A
1
1
2
2
B
6
4
10
5
C
2
1
3
1
D
8
4
12
4
You are required:
Cost Academy
21
(i) to compare an overhead cost per product using activity-based costing tracing overheads to
production units by means of cost drivers.
(ii) To comment briefly on the differences disclosed between overheads traced by the present
system and those traced by activity-based costing.
Solution
Machine-related costs
Machine hours for the period:
A = 500
B = 5000
C = 600 1
D = 70001
=
125
= 1,250
=
600
= 10,500
12,475
Machine hours rate = Rs.3 per hours (Rs.37424/12,475 hrs.)

Set-up related costs. Cost per set-up = Rs.256.18 (Rs.435517)
Set-up cost per unit of output:
Product
A (1 Rs.256.18) / 500 =
B (6 Rs.256.18) / 5000=
C (2 Rs.256.18) / 600 =
D (8 Rs.256.18) / 7000=
Rs.0.51
Rs.0.31
Rs.0.85
Rs.0.29
Materials ordering related costs. Costs per order = Rs.192010 orders = Rs. 192 per order
Materials ordering cost per unit of output:
Product A (1 Rs.192) /500
B (4 Rs.192) / 5000
C (1 Rs.192) / 600
D (4 Rs.192) / 7000
=
=
=
=
Rs.0.38
Rs.0.15
Rs.0.32
Rs.0.11
Materials handling related costs. Cost materials handling = Rs.7,58027 = Rs.280.74

Materials handling cost per unit of output:
Product A (2 Rs.280.75) / 500
= Rs.1.12
B (10 Rs.280.74) / 5000
= Rs.0.56
C (3 Rs.280.74) / 600
= Rs.1.10
D (12 Rs.280.74) /7000
= Rs.0.48
Spare parts
Cost per part = Rs.8,600 12 = Rs.716.67. Administration of spare parts cost per unit of output:
Product
A (2 Rs.716.67) / 500 =Rs.2.87

B (5 Rs.716.67) / 5000 =
Rs.0.72
C (1 Rs.716.67) / 600
=
Rs.1.19
D (4 Rs.716.67) / 7000 = Rs.0.41
Overhead cost per unit of output

Product
ABC overhead cost;
Machine overheads
Set-ups
Materials ordering
Materials handling
Spare parts
Present system
A
Rs.
B
Rs.
C
Rs.
D
Rs.
0.75
0.51
0.38
1.12
2.87
5.53
1.20
0.75
0.31
0.15
0.56
0.72
2.49
1.20
3.00
0.85
0.32
1.40
1.19
6.76
4.80
4.30
0.29
0.11
0.48
0.41
5.79
7.20
Cost Academy
22
Difference
+4.43
+1.29
+1.96
-- 1.40
Production D is the low volume product, and thus the present volume-based recovery shows a
large share of overheads for the product. In contract, the ABC system recognizes that product D
consumers overheads according to activities consumption and traces to low amount of overhead
to this product, as a result proper pricing of the product can be made.
JIT & MRP

1.
The annual demand for an item of raw material is 4,000 units and the purchase price is expected
to be Rs. 90 per unit. The incremental cost of processing an order is Rs. 135 and the cost fo
storage is estimated to be Rs. 12 p.u. What is the optimal order quantity and total relevant cost
of this order quantity?
Suppose that Rs. 135 is estimated to be the incremental cost of processing an order is incorrect
and should have been Rs. 80. All other estimates are correct. What is the difference in cost on
account of this error?
Assume at the commencement of the period that a supplier offers 4,000 units at a price of Rs. 86
each unit. The materials will be delivered immediately and placed in the stores. Assume that the
incremental cost of placing the order is zero and original estimate of Rs. 135 for placing an order
for the economic batch is correct. Should the order be accepted?
Solution
2UP
I
U = Total annual requirement of raw material in units
P = Ordering cost per order
I = Raw materials carrying cost per unit p.u.
2 x 4,000unitsxRs.135
=
= 300 units
Rs.12
Optimal order quantity =

Where,
Total relevant cost when order quantity is 300 units

=
Ordering cost + Carrying cost
=
No. of orders ordering cost per order + order sizecarrying cost per unit p.a.
4,000units
=
135+ 300 unitsRs. 12
300units
=
Rs. 1,800 + Rs. 1,800 = Rs. 3,600
Revised optimal order quantity
2 x 4,000 xRs.80
= 231 units
Rs.12
Revised relevant cost when order quantity is 231 units
4,000units
=
Rs. 80+ 300 unitsRs. 12
231units
=
Rs. 1066.67P + Rs. 1,800 = Rs. 2,866.67 (or say Rs. 2,867) B
Difference in the relevant cost (B-A) on account of wrong estimation of ordering cost
=
Rs. 2,867 Rs. 2,772 = Rs. 95
Total units
Purchased
4,000
price
Rs.
86
Statement of cost at special offer and at the original estimate

order
Total cost of
ordering
Carrying
Total
size (in
purchase
cost
cost
cost
Rs.
Rs.
Rs.
Rs.
4,000
3,44,000
nil
24,000
3,68,000
Cost Academy
23
(4,000Rs. 86)
4,000
90
300
3,60,000
1,800
(4,000Rs. 90)
1,800
3,63,600
Cost difference
4,400
Additional cost of special offer:

Since the special offer of Rs. 86 per unit on the initial purchase of 4,000 units imposes an
additional cost of Rs. 4,400 therefore, such purchase is not recommended.
[For a detailed discussion of other aspects of inventory control students should refer to institute
material of cost accounting at PE II level and prescribed books.]
2.
X Ltd. Manufactures and distributes three types of car (the C1, C2, and C3). Each type of car
has its own production line. The company is worried by extremely difficult market condition and
forecasts losses for the forthcoming year.
Current operations:
The budgeted details for next year are as follows:
C1
Rs.
Direct materials
2,520
Direct labour
1,120
Total direct cost per car
3,640
Budgeted production (cars)
75,000
1,000
Number of order executed
4,000
Machine hours
10,80,000
C2
Rs.
2,924
1,292
4,216
75,000
1,000
5,000
18,00,000
C3
Rs.
3,960
1,980
5,940
75,000
1,500
5,000
16,80,000
Annual overheads:
Set ups
Materials handling
Inspection
Machining
Distribution and warehousing
Fixed
Rs.000
42,660
52,890
59,880
1,44,540
42,900
Variable
Rs.
13,000 per production run
4,000 per order executed
18,000 per production run
40 per machine hour
3,000 per order executed
Proposed JIT system

Management has hired a consultant to advices them on how to reduce costs. The constant has
suggested that the company adopts a just in time (JIT) manufacturing system. The introduction
of JIT system would have the following impact on costs (fixed and variable):
Direct labour
Set ups
Materials handling
Inspection
Machining
Distribution & Ware housing
Increase by 20%
Decrease by 30%
Decrease by 30%
Decrease by 30%
Decrease by 15%
Eliminated
Required:
(a)
Based on the budgeted production levels, calculate the total annual savings that would be
achieved by introducing the JIT system.
The following table shows the price/ demand relationship for each type of car per annum.
C1
C2
C3
Cost Academy
24
Price
Demand
Price
Demand
Price
Demand
(Rs.)
(Rs.)
(Rs.)
5,000
75,000
5,750
75,000
6,500
75,000
5,750
65,000
6,250
60,000
6,750
60,000
6,000
50,000
6,500
45,000
7,750
45,000
6,500
35,000
7,500
35,000
8,000
30,000
Required:
(b) Assuming that X Ltd. Adopts the JIT system and that revised variable overhead cost per car
remains constant (as per the proposed JIT system budget), calculate the profit maximizing
price and output level for each type of car.
Investigations have revealed that some of the fixed costs are directly attributable to the individual
production lines and could be avoided if a line is closed down for the year. The specific fixed
costs for ach of the production lines, expressed as a percentage of the total fixed costs, are:
C1
C2
C3
4%
5%
8%
Required:
(c) Determine the optimum production plan for the forthcoming year (based on the JIT cost
structure and the prices and output levels you recommended in answer to requirement (b)).
(b)
Write a report to the management of X Ltd. Which explains the conditions that are
necessary for the successful implementation of a JIT manufacturing system.
Solution
(a)
The annual cost savings are as follows:
Direct labour 0.2 (Rs. 1,120 + Rs. 1,292 + Rs. 1,980) 75,000
Variable set ups (30% Rs. 13,000) 3,500
Variable materials handling (30% 4,000 14,600)
Variable inspection (30% Rs. 18,000 3,500)
Variable machine (15% Rs. 40 45,60,000)
Variable distribution and warehousing (Rs. 3,000 14,600)
(15% Rs. 1,44,540) + Rs. 42,900]
Total savings
(b)
Rs.000
+ 65,880
- 13,650
- 17,520
- 18,900
- 27,360
- 43,800
- 1,11,210
1,66,560
The total variable overhead costs allocated to each product is as follows:

C1 (Rs.000)
Set up costs at Rs. 9,100 per
Production run
Materials handling at Rs. 2,800
Per order
Inspection at Rs. 12,600 per
Production run
Machining at Rs. 34 per machine
Hours
Total output (000s)
Variable overhead per car (Rs.)
Direct materials per car (Rs)
Direct labour
Total variable cost per car
C2 (Rs.000)
C3 (Rs.000)
9,100
9,100
13,650
11,200
14,000
15,680
12,600
12,600
18,900
37,720
69,620
75
928.26
2,520.00
1,344.00
4,792.26
61,200
96,900
75
1,292.00
2,924.00
1,550.40
5,766.40
57,120
1,05,350
75
1,404.67
3,960.00
2,376.00
7,740.67
Cost Academy
25
The above variable costs per car are now used to derive the following contributions for various
price/ demand levels:
Selling
Price (Rs.)
C1 car
5,000
5,750
6,000
6,500
Demand
unit
Contribution (Rs.)
Total
Contribution (Rs.000)
75,000
65,000
50,000
35,000
207.74
957.74
1,207.74
1,707.74
15,581
62,253
60,387
59,771
C2 car
5,750
6,250
6,500
7,500
75,000
60,000
45,000
35,000
- 16.40
483.60
733.60
1,733.60
- 1,230
29,016
33,012
60,676
C3 car
6,500
6,750
7,750
8,000
75,000
60,000
45,000
30,000
- 1,240.67
- 990.67
9.33
259.33
- 93,050
- 59,440
420
7,780
The profit maximizing price and output levels are Rs. 5,750 and 65,000 demand for C1, Rs.
7,500 and 35,000 for C2 and Rs. 8,000 and 30,000 for C3.
(c)
C1 (Rs.000)
Total contribution
62,253
Avoidable fixed costs
9,266
Contribution to general fixed costs & profit
52,987
C2 (Rs.000)
60,676
11,583
49,093
C2 (Rs.000)
7,780
18,533
- 10,753
The above analysis suggests (ignoring any qualitative factors) that C3 should be discontinued
and that C1 and C2 are produced.
(d)
The report should include the following points:

1. The need to avoid fluctuations in production rates since this will lead to excess work in
progress.
2.
A description of the pull/ Kanban system
3.
The need to ensure a cell production layout and that workers have multiple skills.
4.
Focus on eliminating non value added activities
5.
Focus on routine and preventative maintenance to avoid machine downtime.
6.
Focus on reducing set up times to a minimum
7.
Establishment of JIT purchasing arrangements accompanied by establishing close

relationships with suppliers.
Cost Academy
26
Total Quality management

1.
The budget estimates of a company using sophisticated high speed machines based on
a normal working of 50,000 machine hours during 1986 are as under:
(Rs. lakhs)
Sales (1,00,000 units)
Raw materials
Direct Wages
Factory OverheadsVariable
Fixed
Selling and Distribution OverheadsVariable
Fixed
Administration OverheadsFixed
Total Costs
Profit
100
20
20
10
10
5
5
10
80
20
Since the demand for the company product is high the possibilities of increasing the
production are explored by the budget committee. The Technical Director stated that
maintenance has not been given due importance in the budget and that if preventive
maintenance is introduced, the breakdown repair costs and the hours lost due to
breakdown can be reduced and consequently production can be increased.
In support of this, he presented the following data, showing how injection of more and
more funds on preventive maintenance will bring down the break-down repair costs and
reduce or eliminate stoppages due to breakdown :
Proposed Expenditure on
Preventive Maintenance
Rs.
19200
38,400
76,800
1,53,600
3,07,200
6,14,400
Expenditure Estimated to
by Incurred on Breakdown
Repairs
Rs.
Machine Hours
Saved
1,92,000
1,53,600
1,15,200
76,800
57,600
Nil
800
1,600
2,400
3,200
4,000
Using the different cost and contribution concept, advise the management upto what
level breakdown hours can be reduced to increase production and maximise profits of
the company consistent with minimum costs.
Solution
Workings:
Contribution per unit and per hour:
Sales (1,00,000 units)
Raw materials
Direct wages
Factory overheads (Variable)
Selling & distribution overheads (Variable)
(Rs. lakhs)
100
20
20
10
___5
Cost Academy

Contribution
Contribution per unit: Rs. 45,00,0001,00,000 = Rs. 45
27
55
45
Machine hours planned

50,000
Production units
1,00,000
In one machine hour 2 units will be produced. Hence contribution p. hour: Rs. 45 2 =
Rs. 90.
Statement showing differential cost and incremental contribution at different
levels of machine hours saved.
Machine hours saved
Estimated breakdown
Repair costs (Rs.)
0
1,92,000
800
1,600
2,400
6,200
4,000
1,53,600
1,15,600
1,15,200
76,800
57,600
Differential savings in
Breakdown repair
Costs (Rs.)
38,400
38,400
38,400
19,200
57,600
Incremental contribution (Rs.) (see

note below)
72,000
72,000
72,000
72,000
72,000
Total differential
Savings Rs. (A)
1,10,400
1,10,400
1,10,400
91,200
1,29,600
19,200
38,400
76,800
1,53,600
3,07,200
6,14,400
Differential expenditure on preventive

maintenance (Rs.) (B)
19,200
38,400
76,800
1,53,600
3,07,200
Incremental profit
(Rs.) (AB)
91,200
72,000
33,600
Expenditure on preventive maintenance
62,400 1,77,600
Note: Incremental contribution is calculated by multiplying differential hours saved by

contribution per hour i.e. 800 Rs. 90 = Rs. 72,000
Recommendation : It may be observed from the above table that savings in machine
hours up to 2,400 yields incremental profit. Beyond this level, the differential
maintenance costs exceed the differential savings. Therefore, the management is
advised to reduce the level of breakdown hours upto 1600 (4,000 2,000) or save 2,400
breakdown hours to increase production. AT his level, the company will be able to
maximise profits consistent with minimum costs.
Cost Academy
28
Value chain & Cost Reduction
1.
ACE Ltd has applied Value Analysis during last year. The financial controller of ACE Ltd. has
prepared the following estimates of working results after applying the benefit of vale engineering
for the year ending 31st March, 2006
Direct Materials
Direct Wages
Variable Overheads
Selling Price
Fixed Expenses
Sales
Rs. / units 16.00

Rs. / units 40.00
Rs. / units 12.00
Rs. / units 125.00
Rs. 6,75,000 per annum
Rs. 25,00,000 per annum
During the year 2006-07 , various steps in value analysis are implemented:
1.
Identification of the problem of low labour efficiency; As a result of re-engineering of

business processes, the overall direct labour efficiency will increase by 12%, but the wage
rate will go up by 5%.
2.
Collecting information about function, design, materials, labour, overhead costs, etc., of the
product and finding out the availability of the competitive products in the market. It is
expected that the materials prices and variable overheads will go up by 10% and 5%
respectively.
3.
Exploring and evaluating alternatives and developing them as a result fixed overheads are
also expected to increase by Rs. 1,25,000.
The VP Manufacturing states that the same level of output as obtained in 2005-06 should be
maintained in 2006-07 also and efforts should be made to maintain the same level of profit by
suitable increase the selling price.
The VPMarketing states that the market will not absorb any increase in the selling price. On the
other hand, The proposes that publicity involving advertisement expenses as given below will
increase the quantity of sales as under:
Advertisement Expenses (Rs.)
Additional units of Sales
80,000
2,000
1,94,000
4,000
3,20,000 4,60,000
6,000
8,000
Required:
(a)
Present an Income Statement for 2005-06.
(b)
Find the revised price and the percentage of increase in the price for 2006-07, if the views
of the VPManufacturing are accepted.
(c)
Evaluate the four alternative proposals put forth by the VPMarketing. Determine the best
output level to be budgeted and prepare an over-all Income Statement for 2006-07 at that
level of output.
Cost Academy
29
Solution
(a) Working notes:
1. Number of units produced and sold for the year ending on 31st March,
= Total sales revenue upto 31st March Selling price p.u.
= Rs. 25,00,000 Rs. 125 p.u.= 20,000 units
2.
Statement of variable cost per unit
Year
2005-06
Rs.
16
Direct materials
2006-07
Rs.
17.60
(Rs. 16 + 10% Rs. 16)
Direct wages
40
37.50
(Rs. 40 100/112105/100)
Variable overheads
12
12.60
(Rs. 12 + 5% Rs. 12)
68
67.70
3. Contribution per unit during 1999 -2000

= Selling price per unit Variable cost p.u. =Rs. 125 Rs. 67.70 = Rs. 57.30
4.
Profit in 1998-1999
Contribution per unit
S.P (p.u.)- V.C. (p.u.) =Rs. 125 Rs. 68 = Rs. 57 p.u.
Total contribution
=
Rs. 11,40,000
20,000 units Rs. 57/- p. u.
Less: Fixed expenses
6,75,000
Profit
4,65,000
(a)
Income Statement for the year 1999-2000

Sales revenue 20,000 units Rs. 125
Less: Variable cost
20,000 units X Rs. 67.70 (Refer to working note 2)
Total contribution
Less: Fixed expenses
Profit
(b)
Rs.
25,00,000
13,54,000
11,46,000
8,00,000
3,46,000
Statement for determining revised price and the percentage of increase in the
1999-2000 based on the views of Vice-President- Manufacturing
Rs.
Variable cost (20,000 units Rs. 67.70)13,54,000
Fixed expenses
8,00,000
Profit (Refer working note 4)
4,65,000
Desired sales revenue
26,19,000
Revised selling price (per unit)
130.95
(Rs. 26,19,000/20,000 units)
price
Percentage increase in selling price: Rs. 130.95- Rs. 125 Rs. 125 100 = 4.76%
(c)
Evaluation of four alternative proposals of Vice-President Marketing
Addition units of sales
2,000
Rs.
4,000
Rs.
6,000
Rs.
8,000
Rs.
for
Cost Academy
Total contribution
Less: Advertisement expenses
Addition Profit /(Loss)

1,14,600 2,29,200
80,000
34,600
1,94,000
35,200
3,43,800
4,58,400
3,20,000
23,800
4,60,000
(1,600)
30
Evaluation of four alternatives : Since the additional profit is maximum at the additional sales of
4,000 units, therefore the second alternative is adjudged as the best out of the four alternatives
proposed by the Vice-President of Marketing. Hence the concern should produce and sell 24,000
units during the year 2005-06
Overall Income Statement for 2005-06
24,000 units
Rs.
Sales revenue24,000 units Rs. 125/30,00,000
Output and sales
2.
Less: Variable cost 24,000 units Rs. 67.70

Contribution
16,24,800
13,75,200
Less: Advertisement expenses

Fixed expenses
Profit
9,94,000
3,81,200
Rs. 1,94,000
Rs. 8,00,000
Even Forward Ltd. is manufacturing and selling two products: Splash and Flash at selling price of
Rs 3 and Rs. 4 respectively. The following sales strategy has been outlined for the year :-(i)
Sales planned for year will be Rs. 7.20 lakhs in the case of Splash and Rs. 3.50 lakhs in the
case of Flash.
(ii)
To meet competition, the selling price of Splash will be reduced by 20% and that of Flash by
12 %.
(iii)
Break- even is planned at 60% of the total sale of each product.
(iv)
Profit for the year to be achieved is planned as Rs 69,120 in the case of Splash and Rs
17,500 in the case of Flash. This would be possible by launching a cost reduction
programme and reducing the present annual fixed expenses of Rs. 1,35,000 allocated as
Rs. 1,08,000 to Splash and Rs. 27,000 to Flash.
You are required to present the proposal in financial terms giving clearly the following
information:
Number of units to be sold of Splash and Flash to break-even as well as the total number of units
of Splash and Flash to be sold during the year.
Reduction in fixed expenses product-wise that is envisaged by the Cost Reduction Programme.
Solution
(a) Sales (Rs.)
(b) Sp/u (Revised)
(c) S. units (a/b)
(d) BEP
(e) BEP (cd)
(a) MOS
Splash
Flash
7,20,000
2.4
(80% of 3)
3,00,000
60%
1,80,000
3,50,000
3.5
(87.5% of 4)
1,00,000
60%
60,000
Splash
40%
2,88,000
(1,20,0002.4)
flash
40%
1,40,000
(40,0003.5)
Cost Academy
(b)
(c)
(d)
(e)
(f)
Profit
Previous Fixed cost
New P/V ratio (b/a100)
Revised fixed cost (BESP/V)
Reduction in fixed cost (c-e)

69,120
10,8,000
24%
1,03,680
4,320
31
17,500
27,000
12.5%
26,250
750
Target costing
1.
IBM Ltd. Manufactures and sells computers peripherals to several retail outlets throughout the
country. Amar is the manager of the printer division. Its two largest-selling printers are P1 & P2.
The manufacturing cost of each printer is calculated using IBMs activity based costing system.
IBM has one direct manufacturing cost category (direct materials) and the following five indirect
manufacturing cost pools.
Indirect manufacturing cost pool
Allocation Base
Allocation Rate (Rs.)
1. Materials handling
No. of parts
Rs. 1.20 per part
2. Assembly management
Hours of assembly time
Rs. 40 per hour of assembly time
3. Machine insertion of parts No. of machine inserted parts. Rs. 0.70 per machine inserted part
4. Manual insertion of parts
No. of manually inserted parts Rs. 2.10 per manually inserted part
5. Quality testing
Hours of quality testing time Rs. 25 per testing hour.
Product characteristics of P1 and P2 are as follows:
Product
Direct materials costs
Number of parts
Number of machine inserted parts
Number of manually inserted parts
Hours of quality testing time
P1
Rs. 407.50
85
3.2
48
36
1.4
P2
Rs. 292.10
46
1.9
31
15
1.1
A foreign competitor has introduced products very similar to P1 and P2. Given their announced
selling prices, to maintain the companys market share and profits. Amar estimated the P1 to
have manufacturing cost of approximately Rs. 680 and P2 to have a manufacturing cost of
approximately Rs. 390. he calls a meeting of product designers and manufacturing personnel at
the printer division. They all agreed to have the Rs. 680 and Rs. 390 figures become target costs
for designed version of P1 and P2 respectively. Product designers examine alternative ways of
designing printer with comparable performance but lower costs. They come up with the following
revised designs for P1 and P2 (termed P1 REV and P2 REV, respectively).
Particulars
P1 REV
Direct materials cost
Rs. 381.20
Number of parts
71
2.1
Number of machine inserted parts
59
Number of manually inserted parts
12
Hours of quality testing time
1.2
Required:
Compute the present costs of products P1 and P2 using ABC system.
P2 REV
Rs. 263.10
39
1.6
29
10
0.9
Cost Academy
32
Compute the manufacturing costs of P1 REV and P2 REV. How do they compare with
the Rs. 680 and Rs. 390 target costs?
If the allocation rate in the assembly management activity area can be reduced from Rs. 40
to Rs. 28 per assembly hours, how will this activity area cost reduction affect the
manufacturing costs of P1 REV and P2 REV? Comment on the results.
Solution
P1
Rs/unit
P2
Rs./unit
Material
407.5
Overhead-Material handling (851.2) = 102
Assembly Management (403.2) = 128
Machine insertion
(480.7) = 33.6
Manual insertion
(362.1) = 75.6
Quality testing
(1.425) = 35
Present cost
781.70
292.1
(461.2) = 55.2
(401.9) = 76
(310.7) = 21.7
(252.1)= 31.5
(1.125) = 27.5
504.00
Target cost
Direct material
Overhead:
Material handling
Assembly hour
Machine inspection
Manual inspection
Electronics
Estimated cost
Target cost
680.00
390.00
Revised P1
Rs./unit
381.20
Revised P2
Rs./unit
263.10
(711.2) = 85.2
(2140) = 84.0
(590.7) = 41.3
(122.10) = 25.2
(1.225) = 30.00
646.90
(391.2) = 46.8
(1.640) = 64.0
(290.7) = 20.30
(102.10) = 21.00
(0.925) = 22.50
437.70
680.00
Achieved
390.00
not achieved
Cost Academy
33
Life cycle costing

1.
Bogus Electrical Ltd. (BEL) launches a deluxe type walkman in the market. The market research
study reveals that a demand of 20000 units/month of such Walkman thus launched, exist. The
variable cost/units of it is Rs.640/= and the total fixed overhead is Rs.20,00,000/- per month. The
selling price is 125% of the variable cost. The company adopts a policy of penetrating pricing.
The demand of the walkman per month is given by the equation Q 1 = 2000 t1 - 50 t12, where Q
is the demand in unit and t is the time in months from its introduction in the market. When 50%
of the market has been penetrated, the company changes its pricing policy to 150% of the
variable cost for the subsequent months. The profit earned during maturity stage is Rs.33.0
crores.
A competitor, Worthless Electricals Ltd. (WEL) then enters the market with a peoples band
Walkman having a demand function of Q2 = 2500 t2 - 30 t22. When people is introduced, the
demand in the market rises to 21500 units/month. Deluxes price is reduced to Rs.880 to
combat the price of people at Rs.880 each. When people is introduced, the demand of deluxe
declines, the total market demand remaining the same. When the sale of deluxe drops around
15,000 units/month, BEL discards the product.
Determine the Product Life cycle of deluxe.
Solution
Note 1
Demand for product 1 Q = 2,000 t1 50t12
Demand at maturity 20,000 units
2,000 +50 t2 20,000 = 0
t2 40t +400 = 0
t2 20t 20t+400 = 0
t (t-20) 20 (t-20) = 0
t = 20
So the phase Introduce +Growth = 1-19 & Maturity will start from 20 months
Note-2:
Growth starts when q = 10,000
10,000 = 2,000 t1 50t12
t12 40t1 +200 = 0
40 + (40)2 4,200
t = ---------------------------------------------2
= 5.86 or 34.14 (Always consider lowest one because highest one is towards decline)
Cost Academy
Note-3:
Total profit is maturity = Rs. 33 crore.
(contribution/unit unit/month Fixed cost/Month) = 33 crores
(320 20,000 20 L) months = 33
44,00,000 per month.
So required no. of months = Rs 33 cr. rs. 44 lacks p.m. = 75 months
Maturity period 20-93rd months
Note-4:
At Decline, total demand = 21,500
Demand equation of new product 2.
Q = 2,500 t2 30t22
30t22 2,500t2 +20,000 = 0
3t22 250t2 +2,000 = 0
+250 + 250 -42,0003

6
t= ---------------------------------------------------------t = 74.37 or 8.96

Decline 9 months
Hence the Life of product of BCL
Introduction
Growth
Maturity
Decline
Total
5 months
14
75
9
102 months
34
Cost Academy
35
Shutdown & divestment

1.
Fixed expenses at 50% activity

Fixed expenses when the factory is shut down
Additional expenses in closing down
Production at 50% activity = 5,000 units
Contribution per unit Re. 1
Rs.15,000
10,000
1,000
Solution
A.
B.
C.
D.
If the plant is shut down the sunk costs or fixed expenses

If it is working at 50% activity the fixed expenses
Additional fixed expenses: [(B-A)]
Contribution (5,000 units Re. 1 p.u.)
Rs.
11,000
15,000
4,000
5,000
By working at 50% activity the firm is able to recover the additional fixed expenses of Rs. 4,000
and earn an extra contribution of Rs. 1,000 towards shut down expenses. Hence it is advisable
to continue production in the factory instead of closing it down. If, on the other hand, the
contribution is Re. 0.75 per unit, the total contribution of Rs. 3,750 being less than the additional
fixed expenses, it is not advisable to continue the operations. Hence in the latter case shut down
is economically justified.
2.
A firm produces 10,000 product units a month. Each unit requires 2 kg. of X at Re 1/- per kg. 1
tonne of Y at Rs. 6 and Component Z at Rs. 2. These prices are all fixed by contract with the
firm. To terminate the supply contracts, the firm must give 2 months notice to supplier X, three
months to supplier Y and one month to supplier Z.
Materials supplied could be sold onward on the following terms:
Unit
X per kg
Y per tonne
Z
Sales price
Rs. 1/Rs. 4.80
Rs.1.90
Unit variable selling costs

Rs. 1.20
Rs. 3.20
Rs. 1.50
Unit contribution
Rs.
(0.20)
1.60
0.40
The firm must pay its suppliers during the notice periods but need not take delivery of the
materials if it chooses not to.
Variable conversion costs to the firm are Rs. 25 an hour for 100 hours a month on the product in
question. Among the fixed overheads are machines on hire at Rs. 20,000 a month on a hire
contract subject to three months notice of termination.
Cost Academy
36
The product could be supplied in a finished condition by M. Ltd. , which indicated a price of Rs.
8 per unit would be charged for 10,000 units a month. Should the firm continue to make the
product or buy?
What is the best time to give notice to suppliers and the best time to switch from making to
buying.
Solution
Statement of Net income (if Production stops now)
Saving or CIF
Contribution M1
M2
M3
Rs.
Rs.
Rs.
Material x @ 20,000 p.m.
2 months
--20,000
Resale of mat x
----
M4 & on wards
Rs.
20,000
--
Material Y @ 60,000 p.m. 3 m

Resale Y @ 16,000 p.m.
-16,000
-16,000
-16,000
60,000
--
Material Z @ 20,000 p.m. 1m

Resale Z @ 4,000
-4,000
20,000
--
20,000
--
20,000
--
Conversion cost Nil month

@ Rs. 25 for 100 hrs.
2,500
2,500
2,500
2,500
-_____
22,500
80,000
______
(57,500)
-_____
38,500
80,000
_______
(41,500)
-_______
58,500
80,000
________
(21,500)
20,000
_________
1,22,500
80,000
_______
42,500
Machine rent @ 20,000 p.m. 3m

CIF
COF @ 8 p.u.
For 10,000 units
Net
Decision: Production for 3 months & outsource from 4th month best period of notice.
Material X
: After 1 month
Y
: Now
Z
: After 2 months
Machine
: Now
3.
Short flower Ltd. Currently publish, printing and distribute a range of catalogues and instruction
manuals. The management have now decided to discontinue printing and distribution and
concentrate solely on publishing. Long plant Ltd. will print and distributed the range of
catalogues and instruction manuals on behalf of Short flower Ltd. commencing either at 30 th
June or 30th November. Long plant Ltd. will received Rs.65,000 per month for a contract which
will commence either at 30th June or 30th November .
The result of Short flower Ltd. for a typical month are as follows :
Publishing
Printing
Rs.000
Rs.000
Salaries and wages
28
18
Materials and supplies
5.5
31
Occupancy costs
7
8.5
Depreciation
0.8
4.2
Distribution
Rs.000
4
1.1
1.2
0.7
Other information has been gathered relating to the possible closure proposals:
(i) Two specialist staff from printing will be retained at their present salary of Rs.1,500 each per
month in order to fulfill a link function with Long plant Ltd. One further staff member will be
transferred to publishing to fill a staff vacancy through staff turnover, anticipated in July. This
Cost Academy
37
staff member will be paid at his present salary of Rs.1,400 per month which is Rs.100 more
than that of the staff member who is expected to leave. On closure all other printing and
distribution staff will be made redundant and paid an average of two months redundancy pay.
(ii) The printing department has a supply of materials (already paid for) which cost Rs.18,000
and which will be sold to Long plant Ltd. for Rs. 10,000 if closure takes place on 30 th June .
Otherwise the material will be used as part of the July printing requirements. The distribution
department has a contract to purchase pallets at a cost of Rs.500 per month for July and
August. A cancellation clause allows for non-delivery of the pallets for July and August for a
one-off payment of Rs.300. Non-delivery for August only will required a payment of Rs.100. If
the pallets are taken from the supplier, Longplant Ltd. has agreed to purchased them at a
price of Rs.380 for each months supply which is available. Pallet costs are included in the
distribution material and suppliers cost stated for a typical month.
(iii) Company expenditure on apportioned occupancy costs of printing and distribution will be
reduced by 15% per month if printing and distribution departments are closed. At present,
30% of printing and 25% of distribution occupancy costs are directly attributable costs which
are avoidable on closure, whilst the remainder is apportioned costs.
(iv) Closure of the printing and distribution department will make it possible to sub-let part of the
building for a monthly fee of Rs.2,500 when space is available.
(v) Printing plant and machinery has an estimated net book value of Rs.48,000 at 30 th June. It is
anticipated that it will be sold at a loss of Rs.21,000 on 30 th June . If sold on 30th November
the prospective buyer will pay Rs.25,000.
(vi) The net book value of distribution vehicles at 30th June is estimated as Rs.80,000. They could
be sold to the original supplier at Rs.48,000 on 30th June . The original supplier would
purchase the vehicles on 30th November for a price of Rs.44,000.
Required
Using the above information, prepare a summary to show whether Shortflower Ltd. should close
the printing and distribution departments on financial grounds on 30th June or on 30th November
Solution
Self note:
Printing & Distribution dept. of SF Ltd. Is to be close down its work will be outsourced to L Ltd. at
a fees of Rs. 65,000/month. There are t closer day 30th June & 30th Nov.
If the close is deferred to 30th Nov. instead of 30th June then saving of Cash Flow = 565,000, but
Relevant Cost is to be paid for Net 5 months i.e. cash outflow. If net income is positive then
closer will be deferred, other wise close immediately.
Statement of Net income (if closer is deferred to 30 th Nov)
Rs.
Rs.
Saving in Fees (65,0005)
3,25,000
Less: Relevant Cost for 5 months
S & W (N-1)
94,500
M & S (N-2)
1,52,280
Occupancy cost (N-3)
19,388
Loss of Rent (2,5005)
12,500
Loss on sales of P & M
2,000
Loss on sale of Dist. Of vehicle
_4,000
2,84,668
Net Income
40,332
Close on 30th Nov. (Net income is positive)
Cost Academy
Note-1:
Present cost (18,000+4,000) = 22,0005
Less: Salary of 3 staff 26 retained
i.e. fixed (21,500+1,400)5
38
1,10,000
(22,000)
_______
88,000
Add: Salary of temporary staff in publishing Dept. for 5 months (1,3005)
__6,500
94,500
Redundancy Benefit of 2 month salary is committed, either 30/6 or 30/11 They are always Sunk.
Note-2:
Material & Supply
Total cost for 5 months (31,000 +1,100)5
Less: Stock in hand
1,60,500
__18,000
1,42,500
Add: Opportunity cost i.e. sale to Long plant
___10,000
1,52,500
Less: Save in cost due to proper notice with the supplier which otherwise a cost
Alternative 1: Cancellation change
Alternative 2: Goods purchased & sold to L
2 (500-380)
Alternative 3: one month cancellation
One month resale
Net
300
240
100
120
220
Note-3:
Occupancy cost
(a) Present Cost
(b) Distributable cost
(c) Apportioned occ. cost
(a-b)
Printing
42,500
Distribution
6,000
(8,5005)
(1,2005)
30%
12,750
25%
1,500
29,750
4,500
4,463
675
(d) Shut down in Apportioned cost

(15% of C)
Relevant cost for Defrayment of closure
(b+ d) 17,213 +2,175 = 19,388
__220
1,52,280
Cost Academy
39
Relevant costing & Decision Making:

1.
Tiptop Textiles manufactures a wide range of fashion fabrics. The company is considered
whether to add a further product the Superb to the range. A market research survey recently
undertaken at a cost of Rs. 50,000 suggests that demand for the Superb will last for only one
year, during which 50,000 units could be sold at Rs. 18 per unit. Production and sale of Superb
would take place evenly throughout the years. The following information is available regarding
the cost of manufacturing Superb.
Raw Materials: Each Superb would require 3 types of raw material Posh, Flash and Splash.
Quantities required, current stock levels and cost of each raw material are shown below. Posh is
used regularly by the company and stocks are replaced as they are used. The current stock of
Flash is the result of overbuying for an earlier contract. The material is not used regularly by
Tiptop Textiles and any stock that was not used to manufacture Superb would be sold. The
company does not carry a stock of Splash and the units required would be specially purchased.
Raw
Materials
Posh
Flash
Splash
Quantity
Required
per unit
of Superb
(Metres)
1.00
2.00
0.5
Current
stock
level
(metres)
Rs.
1,00,000
60,000
0
Costs per metre of raw Materials

original
current
current
cost
replacement
resale
cost
Value
Rs.
2.10
3.30
-
Rs.
2.50
2.80
5.50
1.80
1.10
5.00
Labour: Production of each Superb would require a quarter of an hour of skilled labour and two
hours of unskilled labour. Current wage rates are Rs. 3 per hour for skilled labour and Rs. 2 per
hour for unskilled labour. In addition, one foreman would be required to devote all his working
time for one year in supervision of the production of Superb. He is currently paid an annual
salary of Rs. 15,000. Tiptop Textiles is currently finding it very difficult to get skilled labour. The
skilled workers needed to manufacture Superb would be transferred from another job on which
they are earning a contribution surplus of Rs. 1.50 per labour hour, comprising sales revenue of
Rs. 10.00 less skilled labour wages of Rs. 3.00 and other variable costs of Rs. 5.50. it would not
be possible to employ additional skilled labour during the coming year. Because the company
intends to expand in the future, it has decided not to terminate the services of any unskilled
worker in the foreseeable future. The foreman is due to retire immediately on an annual pension
of Rs. 6,000 payable by the company. He has been prevailed upon to stay on for a further year
and to defer his pension for one year in return for his annual salary.
Machinery: Two machines would be required to manufacture Superb MT 4 and MT 7. Details
of each machine are as under:
MT 4
Start of the year

Rs.
Replacement cost
80,000
Rs.
65,000
Cost Academy
MT 7

Resale value
Replacement cost
Resale value
60,000
13,000
11,000
40
47,000
9,000
8,000
Straight-line depreciation has been charged on each machine for each year of its life Tiptop
Textiles owns a number of MT 4 machines, which are used regularly on various products. Each
MT 4 is replaced as soon as it reaches the end of its useful life. MT 7 machines are no longer
used and the one, which would be used for Superb, is the only one the company now has. If it
was not used to produce Superb, it would be sold immediately.
Overheads: A predetermined rate of recovery for overhead is in operation and the fixed
overheads are recovered fully from the regular production at Rs. 3.50 per labour hour. Variable
overhead costs for Superb are estimated at Rs. 1.20 per unit produced.
You are required to compute such a cost sheet for Superb with all details of materials, labour,
overhead etc., substantiating the figures with necessary explanations.
Solution
Details of relevant costs with explanations:
(i) Market Research Survey expenses of Rs. 50,000 is sunk cost and hence not relevant for
the decision on hand.
(ii) Raw materials;
(a) Posh is used regularly and stocks are replaced as they are used. Therefore, its Posh:
50,000 metresRs. 2.50 = Rs. 1,25,000.
(b) 1,00,000 metres of Flash are required for the output of Superb. There are already 60,000
metres in stock as a result of overbuying for an earlier contract purchased @ Rs. 3.30 per
metre, and 40,000 metres additionally would be purchased at the current replacement cost
of Rs. 2.80 per metre. If Superb were not produced, the company would have sold 60,000
metres of Flash at Rs. 1.10. This is an opportunity foregone and relevant. Hence
Flash:Rs.
Incremental cost
40,000 metresRs. 2.80
Opportunity cost
60,000 metresRs. 1.10
(c)
1,12,000
___66,000
__1,78,000
25,000 metres of splash would be specially purchased for the output

Splash 25,000 metresRs. 5.50 = Rs. 1,37,500
(iii) Labour:
To manufacture 50,000 units of Superb
Skilled labour required: 50,0001/4 = 12,500 hours and
Unskilled labour required: 50,0002 = 1,00,000 hours
Wage rate for skilled labour is Rs. 3 per hour. If Superb were not manufactured and the
skilled labour were not transferred, they would have given a clean contribution of Rs. 1.50
per hour. This is the cost of an opportunity foregone:
Therefore:
Cost of skilled labour:
Rs.
Cost of deployment (12,500Rs. 3)
37,500
Add: Opportunity cost (12,500Rs. 1.50)18,750
56,250
Unskilled labour:
Cost Academy
41
No work has suffered and no extra cost is involved hence cost of unskilled labour: zero
Foreman:
Annual salary
Less: Pension saved
Effective cost
Rs.
15,000
__6,000
__9,000
(iv) Machinery: MT 4 machines are used and replaced regularly. The difference of the
replacement cost between start and end of the year is relevant. Hence, MT 4 cost of using:
Rs. 15,000
MT 7 machine is not in vogue and will be sold now or in near future. The fall in its resale
value represents the relevant cost.
Hence, cost of using MT 7: Rs. 11,000 Rs. 8,000 = Rs. 3,000
(v)
Overheads: Fixed overheads have been recovered fully from existing production. So its rate
of recovery is not relevant. Variable overheads: 50,000Rs. 1.20 = Rs. 60,000
Now we can prepare the cost sheet.
Cost sheet for 50,000 units of Superb

Rs.
Rs.
Raw Materials:
Posh
1,25,000
Flash
1,78,000
Splash
1,37,500
4,40,500
Labour:
Skilled
56,250
Unskilled
0
Foreman
___9,000
65,250
Machinery costs:
MT 4
15,000
MT 7
__3,000
18,000
Variable overheads
__60,000
Total cost
5,83,750
Profit (Rs. 9,00,000 Rs. 5,83,750)
3,16,250
Sales revenue (50,000Rs. 18)
9,00,000
________________
2.
The officers Recreation Club of a large public sector undertaking has a cinema theatre for the
exclusive use of themselves and their families. It is a bit difficult to get good motion pictures for
show and so pictures are booked as and when available. The theater has been showing the
picture Blood Bath for the past two weeks. This picture, which is strictly for adults only, has
been great hit and the Manager of the theatre is convinced that the attendance will continue to be
above normal for another two weeks, if the show of Blood Batch is extended. However, another
popular movie, eagerly looked forward to by both adults and children alike, -Appu on the Airbus
is booked for the next two weeks. Even if Blood Bath is extended, the theatre has to pay the
regular rental on Appu on the Airbus as well.
Normal attendance at the theater is 2,000 patrons per weeks, approximately one-fourth of whom
are children under the age of 12. Attendance for Blood Bath has been 50% greater than the
normal total. The manager believes that this would taper off during a second two weeks, 25%
below that of the first two weeks during the third week and 33.33% below that of the first two
weeks during the fourth weeks. Attendance for Appu on the Airbus would be expected to be
normal throughout its run, regardless of the duration.
All runs at the treatre are shown at the regular price of Rs. 2 for adults and Rs. 1.20 for children
under 12. The rental charge for Blood Bath is Rs. 900 for one week or Rs. 1,500 for two
Cost Academy
42
weeks. For Appu on the Airbus it is Rs. 750 for one week or Rs. 1,200 for two weeks. All other
operating costs are fixed Rs. 4,200 per week, except for the cost of potato wafers and cakes,
which average 60% of their selling price. Sales of potato wafers and cakes regularly average Rs.
1.20 per patron, regardless of age.
The Manager can arrange to show Blood Bath for one week and Appu on the Airbus for the
following week or he can extend the show of Blood Bath for two weeks; or else he can show
Appu on the Airbus for the weeks, as originally booked. Show by computation, the most
profitable course of action he has to pursue.
Solution
The officers recreation club
Comparative predicted income for two weeks
Three decision alternatives
Show Blood Bath
Show Blood Bath
For two weeks
for one week and
Appu on the Airbus
two weeks
for the following week
Attendance:
Adults:
First week
Second week
Children:
First week
Second week
Total attendance
Revenue:
Sales of Tickets:
Adults@ Rs. 2/Children @ Rs. 1.20
Sale of potato wafers & cakes
@ Rs. 1.20 per patron
Total revenue: (A)
Costs (only relevant):
Hire Charges of
Blood Bath
Cost of potato wafers & Cakes
(60% of their selling price)
Total relevant cost: (B)
Profit: {(A) (B)}
2,250
2,000
5,250
2,250
1,500
3,750
1,500
1,500
3,000
--___--__
_4,250
--__500
4,250
500
__500
4,000
Rs.
Rs.
Rs.
8,500
---
7,500
600
6,000
1,200
5,100
13,600
5,100
13,200
4,800
12,000
1,500
900
---
3,060
4,560
9,040
3,060
3,960
9,240
2,880
2,880
9,120
It is seen from the above statement that the most profitable course of action is to show each film
for one week. Hence, the manager should arrange to show Blood Bath for one week and
Appu on the Airbus for the following week.
Note: The hire charge for Appu on the Airbus and the fixed operating costs of Rs. 4,200 per
week are irrelevant to this analysis as these are committed fixed costs.
_______________
3. (a) A machine, which originally cost Rs. 12,000 has an estimated life of 10 years and is depreciated
at the rate of Rs. 1,200 per year. It has been unused for sometime, however, as expected
production orders did not materialize. A special order has now been received which would
required the use of the machine for two months.
Cost Academy
43
The current net realizable value of the machine is Rs. 8,000. If it is used for the job, its value is
expected to fall to Rs. 7,500. The net book value of the machine is Rs. 8,400. Routine
maintenance of the machine currently costs Rs. 40 per month. With use, the cost of
maintenance and repairs would increase to Rs. 60 per month.
What would be the relevant cost of using the machine for the order so that it can be charged as
the minimum price for the order?
(b)
X Ltd. has been approached by a customer who would like a special job to be done for him and
is willing to pay Rs. 22,000 for it. The job would require the following materials:
Material
Total
Realizable
Units
value
Required
Units
Replacement
already
cost
in stock
Rs./units
Rs./units
A
1,000
B
1,000
C
1,000
D
200
0
600
700
200
--2
3
4
--2.5
2.5
6
6
5
4
9
(i) Material B is used regularly by X Ltd. and if stocks are required for this job, they would need
to be replaced to meet other production demand.
(ii) Materials C and D are in stocks as a result of previous excess purchase and they have
restricted use. No other use could be found for material C but material D could be used in
another job as substitute for 300 units of material E which currently costs Rs. 5 per unit (of
which the company has no units in stock at the moment).
What are the relevant costs of material, in deciding whether or not to accept the contract?
Assume all other expenses on this contract to be specially incurred besides the relevant cost
of material is Rs. 550.
Solution
(a)
Relevant costs of using the machine for the order
(i) Loss in the net realizable value of machine by using it on the order
(Rs. 8,000 Rs. 7,500)
(ii) Additional maintenance and repair for two months, i.e. (Rs. 60 Rs. 40)2
Minimum price
Rs.
500
__40
___540
Notes:
(a) (i) Books value of Rs. 8,400 is irrelevant for decision.
(ii) Net realizable value of the machine fall from Rs. 8,000 to Rs. 7,500. This loss of Rs. 500
is relevant for decision, because it is influenced exclusively by the decision.
(iii) Rs. 7,500 will be realized after months at least. Therefore, time value of Rs. 7,500 for two
month at least. Therefore, present value of future realizable value of Rs. 7,500 should be
found out & this present value should be deducted from Rs. 8,000. This will be the correct
relevant cost in place of Rs. 500 shown above in the absence of discounting factor.
(b) (i) Material A is not yet owned. It would have to be purchased in full at the replacement cost
of Rs. 6.00 per unit. Relevant cost is therefore 1,000 units at the replacement cost.
(ii) Material B is used by the company regularly. There is already existing a stock of 600
units. If these are used in the contract, a further 400 units would have to be purchased.
Cost Academy
44
Relevant cost is therefore 1,000 units at the replacement cost.

(iii) Material C: 1,000 units of material C are required. 700 units are already in stock. If it is
used for the contract, a further 300 units will have to be purchased at a replacement cost
of Rs. 4.00 each. The existing stock of 700 units will not be replaced. If they are used for
the contract, they cannot be used @ Rs. 2.50 each unit. The realizable value of these
units 700 units @ Rs. 2.50 per unit represent opportunity cost.
(iv) Material D is already in stock and will not be replaced. There is an opportunity cost of
using D in the contract. It has following two uses:
It can be sold to fetch Rs. 1,200 i.e., 600Rs. 2. it can also be used for E, which would
cost Rs. 1,500 i.e., 300Rs. 25. Since substitution is more useful, Rs. 1,500 is the
opportunity cost.
(c)
Summary of relevant costs:

Material A
Material B
Material C
Material D
Other expenses
Total relevant cost
1,000 unitsRs. 6
1,000 unitsRs. 5
700 unitsRs. 2.5
300 unitsRs. 4
300 unitsRs. 5
Rs.
6,000
5,000
1,750
1,200
1,500
__550
16,000
(d)
Contract should be accepted since offer is Rs. 22,000 in relation to relevant cost of Rs. 16,000.
4.
Estimated direct material requirements of a business concern viz. ABC Ltd. for the year 1998-99
are 1,00,000 units. Units cost for orders below 1,20,000 units is Rs. 10. when size of order
equals 1,20,000 units or more the concern received a discount of 2% on the above quoted per
unit price. Keeping in view the following two alternatives:
(i)
Buy 1,20,000 units at the start of the year; (ii) Buy 10,000 units per month.
Calculate the opportunity cost, if the concern has the facility of investing surplus funds in
government bonds at the rate of 10% interest.
Solution
Average investment in inventory under the given two alternatives are:
(i) (1,20,000 unitsRs. 9.80)/2
= Rs. 5,88,000
(ii) (10,000 unitsRs. 10)/2
=
Rs. 50,000
Difference between the average investments in inventory under:
Alternatives (i) & (ii) is (Rs. 5,88,000 Rs. 50,000) = Rs. 5,38,000
The concern can invest Rs. 5,38,000 at 10% and can earn Rs. 53,800 as interest annually. The
sum of Rs. 53,800 is an opportunity foregone if alternative (i) is chosen. Hence Rs. 53,800 is the
opportunity cost of the Rs. 1,20,000 units purchase order.
Note; Rs. 53,800 would not ordinarily be recorded in the accounting system, as it is a foregone
cost.
5.
A company produces a certain waste, which can be sold at a salvage price of Re. 0.90 per kg.
The company wants to process the waste product further at a labour and overhead cost of Re.
0.75 per kg. And sell it at a higher price of Rs. 1.60 per kg. Here the sale value of processed
waste has no meaning unless we take into account the opportunity cost, viz. the disposal value
Cost Academy
45
of waste product. While analyzing the profitability of processing the waste further, the salvage
value of waste should, therefore, be taken into consideration as opportunity cost as under:
Waste
Sold
Rs.
0.90
-__--_
__--_
0.90
Waste
processed
Rs.
1.60
0.75
_0.90
_1.65
(0.05)
Income per kg. (A)

Labour & overheads
Opportunity cost of waste
Total cost: (B)
Net gain (Loss): {A B}
Solution
It is not advisable to process the waste further since it incurs a loss of 5 paise per kg. After taking
into account the opportunity cost of waste. Thus the opportunity cost represents the maximum
contribution foregone by using the limited resources for a particular purpose.
Use of opportunity cost concept in capital expenditure decision
The concept of opportunity cost can be used with advantage in capital expenditure decision
using time value of money. This can be illustrated as under:
An owner of a plot of land has three proposals as under:
A.
B.
Sell the plot now for a net income of Rs. 1,00,000.

Rent out the land at an annual net rental of Rs. 8,000 for 25 years and thereafter sell it for a
value of Rs. 1,50,000.
C.
Spend Rs. 10,00,000 in construction of building now and thereafter rent out the building at a
net annual rental of Rs. 1,10,000 for 25 years. Thereafter sell the building for Rs. 3,00,000.
Taking the rate of return at 10% advise as to which of the three alternatives is the most profitable
course of action.
Taking the rate of return at 10% the result may be tabulated as under:
A
B
Sell now
Rent out
The land
(rent out)
Rs.
Rs.
0 (initial year)
1,00,000
Nil
1 to 25 years
--2,00,000
After 25 years
--1,50,000
Net cash inflow
1,00,000
3,50,000
Net present value of cash inflow @ 10%
1,00,000
86,416
C
Construct
building
Rs.
- 10,00,000
27,50,000
3,00,000
20,50,000
26,070
In this Problem, the opportunity costs of three alternatives are shown explicitly. The first
alternative, namely, to sell now yields the highest net present value and hence it is acceptable.
_________
6.
Zed Ltd. operates two shops. Products A is manufactured in shop 1 and customers jobs
against specific orders are being carried out in shop 2. its annual statement of income is:
Sales/Income
Material
Shop 1
(Product A)
Rs.
1,25,000
40,000
Shop 2
Total
Rs.
2,50,000
50,000
Rs.
3,75,000
90,000
Cost Academy
Wages
Depreciation
Power
Rent
Heat & light
Other expenses
Total costs
Net income
45,000
18,000
2,000
5,000
500
4,500
1,15,000
10,000
1,00,000
31,500
3,500
30,000
3,000
2,000
2,20,000
30,000
46
1,45,000
49,500
5,500
35,000
3,500
6,500
3,35,000
40,000
The depreciation charges are for machines used in the shops. The rent and heat and light are
apportioned between the shops on the basis of floor area occupied. All other costs are current
expenses identified with the output in a particular shop.
A valued customer has given a job to manufacture 5,000 units of X for shop 2. As the company
is already working at its full capacity, it will have to reduce the output of product A by 50%, to
accept the said job. The customer is willing to pay Rs. 25 per unit of X. The material and labour
will cost Rs. 10 and Rs. 18 respectively per unit. Power will be consumed on the job just equal to
the power saved on account of reduction of output of A. in addition the company will have to
incur additional overheads of Rs. 10,000.
You are required to compute the following in respect of this job.
(a) Differential cost;
(b)
Full costs;
(c) Opportunity cost; and
(d)
Sunk cost
Advise whether the company should accept the job.
Solution
(a)
Differential cost of the Job:
Material cost
Labour cost
Additional overheads
Other expenses
Total
Increase
Rs.
50,000
90,000
10,000
___--__
1,50,000
Decrease
Rs.
20,000
22,500
--_2,250
44,750
Net differential cost of the jobs: Rs. 1,05,250 (Rs. 1,50,000 Rs. 44,750)
Note: Depreciation, rent, heat and light and power are not going to affect the costs.
(b)
(c)
Full cost of the jobs:

Cost as above at (a)
(i.e., increased costs)
Depreciation
Power
Rent
Heat & light
Rs.
1,50,000
9,000
1,000
2,500
__250
1,62,750
Opportunity cost of taking the order:
Rs.
Sales product A
Less: Material
20,000
Labour
22,500
Power
1,000
Other expenses
2,250
Rs.
62,500
45,750
16,750
Cost Academy
(d)
47
Sunk cost of the jobs:

Depreciation
Power*
Rent
Heat & light
Rs.
9,000
1,000
2,500
___250
12,750
* If a student treats power as a relevant cost, in that case it would not appear here.
Advice regarding the jobs:
Zed Ltd. should not accept the job as there will be a cash disadvantage of Rs. 42,750 as
computed below:
Rs.
Rs.
Incremental revenue
5,000 units @ Rs. 25
1,25,000
Less: Sale of product A
__62,500
62,500
Differential costs (a)
1,05,250
Cash disadvantage
__42,750
_____________
7.
The Z company owns a operates a chain of 25 stores. Budgeted data for the Garden stores are
as follows:
Rs.
Annual sales
4,25,000
Annual cost of goods sold and other operating expenses 3,82,000
Annual building ownership costs (not included above)
20,000
The company can lease the building to a large flower shop for Rs. 4,000 per month decide
whether to continue operations of this store or to lease using:
(i)
The total project (or comparative statement) approach
(ii)
The incremental (or relevant cost) approach
(iii) The opportunity cost approach
Solution
(i)
Comparative statement showing the profitability of two alternatives
Continue operationLease the building
Rs.
Rs.
Annual sales
4,25,000
48,000(@ 4,000 p.m.)
Less: Cost of goods sold
3,82,000
--(Excluding ownership costs)
Building ownership costs
__20,000
20,000
Net income
__23,000
28,000
Net income is Rs. 28,000 if the building is leased out and thus leasing is a profitable proposition.
(ii)
Incremental or relevant cost approach.

Building ownership costs are not relevant as there is no change in these costs under both the
alternatives. Therefore, the correct approach will be to consider to incremental cash inflows from
the continuing operation.
Rs.
Net cash flow from continuing the operation (Rs. 4,25,000 Rs. 3,82,000)
43,000
Less: Income from leasing
48,000
Incremental loss from continuing operations
(5,000)
Therefore, company should not continue the operation
(iii)
The opportunity cost approach
Cost Academy
Total sale revenue

Less: Cost of goods sold
Opportunity cost of leasing
Therefore, the company should lease out the building
_____________
8.
48
Rs.
4,25,000
(3,82,000)
__(48,000)
____5,000
Universe Ltd. manufactures two products X and Y. It is facing severe competition in the market.
The monthly sales potential in units at different selling prices as anticipated by the Sales Manger
are as under:
Product-X______________
Product-Y
Selling price
Sales potential
Sales potential
Per unit (Rs.)
(in units)
per unit (Rs.)
(in units)
110
5,000
78
30,000
108
7,500
77
32,000
107
8,000
75
35,000
103
8,400
72
40,000
96
9,000
69
45,000
The total costs as disclosed by the budgets of the company are as follows:
Product X
Product-Y
Output and sales per month (units)
5,000
30,000
45,000
Total costs per month (Rs. In lakhs)
56.6
18
25.5
Labour hours needed per month
20,000
60,000
90,000
You are required to find out the selling price and units to be sold to earn maximum profit where
(a) labour hours are available without any restriction and (b) only 95,000 hours are available.
Solution
Working Notes:
1.
Computation of variables cost p.u. and fixed cost (p.m.)

of two products X and Y of Universe Ltd.
Products
X
Rs.
40
Rs.1,60,000
Change
in total cost of a product
----------------------------------------------Change in the output of the product 4,000units
Fixed cost
(Total cost-variable cost)
2.
Y
Rs.
50
Rs.7,50,000
15,000units
3,00,000
3,00,000
(Rs. 5,00,000-(Rs. 18,00,000 Rs. 2,00,000) Rs. 15,00,000)
Selling price and sales level of maximum contribution

Product-X
Product-Y
Selling
contribution
units
Total
selling
contribution
units total
Price p.u.
per unit
contribution price p.u
(SP-VC)
contribution
Rs.
Rs.
(Rs. Lakhs)
Rs.
Rs.
(Rs. Lakhs)
110
70
5,000
3.5
78
28
30,000
8.4
108
68
7,500
5.1
77
27
32,000
8.64
107
67
8,000
5.36
75
25
35,000
8.75
103
63
8,400
5.292
72
22
40,000
8.80
96
56
9,000
5.04
69
19
45,000
8.55
Cost Academy
49
Maximum contribution of two products X and Y are Rs. 5.36 (Lakhs) and Rs. 8.80 (Lakhs) at
selling prices Rs. 107 and Rs. 72 respectively.
3.
Incremental contribution per labour hour of products X and Y

(Refer to working note 2)
Product-X
Selling incremental incremental contribution selling
Price
contribution
labour hrs per hour
price
Per unit
per unit
Rs.
Rs. Lakhs
units4 hrs
Rs.
Rs.
(1)
(2)
(3)
(2)/(3)=(4)
(6)
(7)
(6)/(7) = (8)
110
3.5
20,000
17.50
78
108
1.6
10,000
16.00
77
107
0.26
2,000
13.00
75
103
(-0.068)
1,600
(-4.25)
72
96
(-0.252)
2,400
(-10.50)
69
4.
Sl No.
1.
2.
3.
4.
5.
6.
7.
(a)
(b)
Product Y
incremental
incremental
contribution
labour hrs
Rs. Lakhs (Units2 hrs)
8.40
0.24
0.11
0.05
(-0.25)
60,000
4,000
6,000
10,000
10,000
contribution
per hour
Rs.
14.00
6.00
1.83
0.50
(-2.50)
Ranking of products X and Y based on the incremental

Contribution per hour as per working note 3
selling price
Product
Ranking
Contribution per hour
Rs.
Rs.
110
108
78
107
77
75
72
17.50
16.00
14.00
13.00
6.00
1.83
0.50
X
X
Y
X
Y
Y
Y
Statement of selling price and units to earn maximum profit

(No restriction on the availability of labour hours)
Products
X
Y
Total
Output and sales (in units) of
Optimum contribution per month (1)
8,000
40,000
Selling price p.u. (Rs.)
107
72
Contribution (Rs./units)
(2)
67
22
Total contribution (Rs.)
(1)(2)
5,36,000
8,80,000 14,16,000
Less: Fixed cost (Rs.)
3,00,000
3,00,000
6,00,000
_________
Profit
8,16,000
Statement of selling price and units to earn

Maximum profit when only 95,000 labour hours are available
Products
selling
incremental
incremental
Labour
Price
contribution
units
hours
contribution
I
II
III
IV
V
VI
VII
Cost Academy

Per labour
Hour
50
in (Lakhs)
Rs.
Rs.
(2)
(1)
(5)
X
X
Y
X
Y
110
108
78
107
77
(3)
(3)(5) = (6)
17.50
16.00
14.00
13.00
6.00
5,000
2,500
30,000
500
1,500*
95,000
Less: Fixed costs

Profit
Balancing figure
9.
20,000
10,000
60,000
2,000
3,000*
13.94
__6.00
7.94
3.50
1.60
8.40
0.26
___0.18
A Company produces three products from an imported material. The cost structure per unit of
the products are as under:
Products
A
B
C
Rs.
Rs.
Rs.
Sales value
200
300
250
Direct materials
50
80
60
Direct wages Rs. 6 per hour
60
120
108
Variable overheads
30
60
54
Out of Direct material 80% is of the imported material @ Rs. 10 per kg.
Prepare a statement showing comparative profitability of the three products under the following
scenarios:
(i) Imported material is in restricted supply.
(ii) Production capacity is limiting factor.
(iii)
When maximum sales potential of products A and B are 1,000 units each and that of
product C is 500 units for specific requirement, availability of imported material is restricted
to 10,000 kgs per month, how the profit could be maximized?
Solution
Working Notes:
Value of imported and indigenous material and quantity of imported material consumed P.u..:
Products
A
B
C
Value of imported material p.u. (Rs.)
40
64
48
Value of indigenous material p.u. (Rs.)
10
16
12
Quantity of imported material consumed p.u. (Kg.) 4
6.4
4.8
Statement of profitability
Products
A
Sales value p.u. (Rs.) : (X)
200
Direct material (Rs.)
50
Direct wages (Rs.)
60
B
300
80
120
C
250
60
108
(20 hrs. Rs. 6)
(18 hrs Rs. 6)
__30
140
60
__60
260
40
__54
222
28
30%
13.33%
11.2%
(10 hrs Rs. 6)
Variable overheads (Rs.)

Total variable cost (Rs.) : (Y)
Contribution p.u. (Rs.): (X-Y)
C
x100
P/V ratio:
S
Cost Academy
Contribution per kg. Of imported materials (Rs.)

(Refer to working note)
15
Contribution per hour of production (Rs.)
6
(60/10 hrs.)
6.25
21.6
5.83
(40/20 hrs)
(28/18 hrs)
(i)
When imported material is in restricted supply then product A is most profitable one.
(ii)
Even when production capacity is limited, product A is the most profitable one.
(iii)
Statement for maximized profit

Products
A
Maximum sales (units)
1,000
Requirement of imported material p.u. (kg)
4
Total requirement of imported material for
Maximum sales (kg.)
4,000
Contribution per kg. (Rs.)
15
B
1,000
6.4
C
500
4.8
6,400
6.25
2,400
5.83
3,600
562
22,480
2,400
500
14,000
51
For maximizing profit 10,000 kg. Of imported

Material is to be used for manufacturing those
Products where contribution per kg is maximum.
But 500 units of C must be produced to meet
Specific requirement. Hence the material
Utilized will be (Kg.)
No. of units
Maximum profit (Rs.)
10.
4,000
1,000
60,000
Somesh of Agra presently operates its plant at 80% of the normal capacity to manufacture a
product only to meet the demand of Government of Tamil Nadu under a rate Contract.
He supplies the product for Rs. 4,00,000 and earns a profit margin of 20% on sales realizations.
Direct cost per unit is constant.
The indirect costs as per his budget projections are:
Indirect costs
20,000 units
(80% capacity)
Rs.
Variable cost
80,000
Semi-variable
40,000
Fixed cost
80,000
22,500 units
(90% capacity)
Rs.
90,000
42,500
80,000
25,000 units
(100% capacity)
Rs.
1,00,000
45,000
80,000
He has received an export order for the product equal to 20% of its present operations.
Additional packing charges on this order will be Rs. 1,000.
Arrive at the price to be quoted for the export to give him a profit margin of 10% on the export
price.
Solution
Working notes:
1. Direct cost per unit
Selling price per unit
(Rs. 4,00,000/20,000 units)
Less: profit margin (20%Rs. 20)
Total cost
Less: Indirect costs
(Rs. 2,00,000/20,000 units)
Rs.
20
__4
16
__10
Cost Academy
Direct cost per unit

2.
Direct cost @ Rs. 6/- p.u.

Indirect cost:
Variable @ Rs. 4/- p.u.
Semi variable
Fixed
Total
52
___6
Statement of differential cost for 4,000 units
(20% of 20,000 units)
Present
proposed
Production
production
20,000
24,000
units
units
Rs.
Rs.
1,20,000
1,44,000
80,000
40,000
80,000
3,20,000
96,000
44,000
81,000
3,65,000
Differential
cost for
4,000
units
Rs.
24,000
16,000
4,000
1,000
45,000
Computation for the price to be quoted for the export order of 4,000 units.
Rs.
Differential cost
45,000
(Ref. To working note 2)
Add: Profit
5,000
(10% of export price or 1/9th of cost)
_______
Price to be quoted
_50,000
Export price per unit;
(Rs. 50,000/4,000 units)
Rs. 12.50
___________
11.
A company can produce and sell at its maximum capacity 20,000 units of a product. The sale of
price is Rs. 100. The present sales 15,000 units. To produce over 20,000 units and up to
another 10,000 units some balancing equipments are to be installed at a cost of Rs. 10 lakhs and
the same will have a life span of 10 years.
The current cost structure is as under:
Direct material
Direct labour
Variable overheads
Profit
30% of sales value

20% of sales value
Rs. 20 per unit
Rs. 15 per unit
The present cost is estimated to go up due to price escalation as under:

10% in Direct material from present level of 30%
25% in Direct Labour from present level of 20%
Rs. 50,000 in Fixed overheads per year.
There is a concrete proposal from a party to take 10,000 units additionally over the present level
of output on a long-term basis at a unit price of Rs. 90. Apart from the investment of Rs. 10
lakhs, as shown above, the fixed overheads will increase by Rs. 50,000 due to additional
administrative expenses.
The Company is in a dilemma as to whether to accept the order for 10,000 units or to use the
present unused capacity of 5,000 units for which there will be additional selling expenditure of
Rs. 50,000.
Ignore financing charges and give your recommendation.
Solution
Working Note:
Fixed overheads:
Rs.
Cost Academy
Present sales value: (A) (15,000 unitsRs. 100)

Direct Materials (30% of sale value)
15,00,000
4,50,000
Direct labour (20% of sale value)

Variable overheads (Rs. 20 per unit)
Total variable costs: (B)
3,00,000
3,00,000
10,50,000
Contribution: (C) : (A) (B)

Profit: (D) (15,000 units15)
Fixed overheads: (C) (D) (current level)
Add: Additional fixed overheads due to price escalation
Total fixed overheads
4,50,000
2,25,000
2,25,000
__50,000
2,75,000
Alternatives
Statement of profitability for various alternatives

I
II
III
53
IV
Rejecting the proposal rejecting the proposals

Accepting the
Accepting the
For the purchase of
for the purchase of
proposal of
proposal of
10,000 units &
10,000 units from a
the party to take party to take
Continuing with
party and attaining
10,000 units @ 10,000 units @
Present level of
the maximum capacity
Rs. 90 p.u. by
Rs. 90 p.u. by
Sales only
by incurring additional
installing a
installing a
Selling expenditure balancing equipment balancing
& Continuing with equipment &
Present level of attaining sale of
Sales
maximum available
Capacity by incurring
Additional selling
Expenditure
Sales (Units)
Sales value: (A)
Variable costs:
Direct materials
(33% of sales value)
Direct Labour
(25% of sale value)
variable overheads
(@ Rs. 20 per unit)
total Variable costs: (B)
15,000
Rs.
15,00,000
20,000
Rs.
20,00,000
25,000
Rs.
24,00,000
30,000
Rs.
29,00,000
(15,000Rs. 100)
(20,000Rs. 100)
+ 10,000Rs. 90)
(15,000Rs. 100
+ 10,000Rs. 90)
(20,000Rs. 100
+ (10,000Rs. 90)
4,95,000
6,60,000
8,25,000*
9,90,000*
3,75,000
5,00,000
6,25,000*
7,50,000*
3,00,000
_________
11,70,000
4,00,000
5,00,000
6,00,000
15,60,000
19,50,000
23,40,000
Fixed costs:
2,75,000
2,75,000
2,75,000
2,75,000
Additional selling
Expenditure
--50,000
--50,000
Deprecation for
Balancing equipment
----1,00,000
1,00,000
Additional administrative
Expenses
______----50,000
50,000
Total fixed costs: (C)
2,75,000
3,25,000
4,25,000
4,75,000
Total costs D: [(B)+(C)]
14,45,000
18,85,000
23,75,000
28,15,000
Profit : (A) (D)
55,000
1,15,000
25,000
85,000
* Note: For computing the material and labour cost under alternative III & IV the notional sale
price of Rs. 100 is taken for additional 10,000 units.
Cost Academy
54
Recommendations: Alternative II is the best as it gives maximum profit.

11.
R. Ltd. will produce 3,00,000 kgs. Of S and 6,00,000 kgs. Of Y from an input of 9,00,000 kgs. Of
raw material Z.
The selling price of S is Rs. 8 per kg. And that of Y is Rs. 6 per kg.
Processing costs amount to Rs. 54 lakhs per month as under:
Rs.
Raw material Z 9,00,000 kgs. at Rs. 3 per kg.
27,00,000
Variable processing costs
18,00,000
Fixed processing costs
9,00,000
Total
54,00,000
There is an offer to purchase 60,000 kgs of Y additionally at a price of Rs. 4 per kg. The existing
market for Y will not be affected by accepting the offer. But the price of S is likely to be decreased
uniformly on all sales.
Find the minimum reduced average price for S to sustain the increased sales.
Solution
Since S & Y are produced simultaneously from an input of raw material Z, therefore when
additional 60,000 kgs. of Y will be produced then 30,000 kgs. of S will also be produced
simultaneously. The input of material Z required for these additional 60,000 kgs of Y and 30,000
kgs. of S will be 90,000 kgs. of material Z. Hence the cost of processing 90,000 kgs. of material
will be as follows:
Rs.
Cost of raw material Z
2,70,000
(90,000 kgs.Rs. 3)
Variable processing cost
1,80,000
(90,000 kgs.Rs. 2)
________
Total cost of processing
4,50,000
Less: Sales revenue from 60,000 kgs. of Y
2,40,000
(60,000 kgsRs. 4)
_________
Balance cost to be recovered
2,10,000
Current sales revenue from the sale of 3,00,000 kgs. of S
24,00,000
(3,00,000 kgs. Rs. 8)
total sales revenue to be earned from the sale of S
26,10,000
(3,00,000 kgs + 30,000 kgs.)
Hence, minimum price per kg. Of S to recover
Rs. 26,10,000 from the sale of 3,30,000 kgs. of S
(Rs. 26,10,000/3,30,000 kgs.)
7.91
Make or Buy decision: Very often management is faced with the problem as to whether a part
should be manufactured or it should be purchased from outside market. Under such
circumstances two factors are to be considered:
a)
b)
Whether surplus capacity is available, and

The marginal cost.
Cost Academy
55
Budget
1.
The budgeted level of activity of a production department of a manufacturing company is 5,000

hours in a period. But a technical study assumes overhead behaviour mentioned below :Rs(00) Per hr.
0.40
Indirect wages, variable cost,

Rent and Tax, fixed cost
Consumable supplies, variable
Total in Rs(000).
320
0.24
Repairs : up to 2,000 hours

additional each extra 500 hrs up to 4,000 hrs.
additional 4,001 to 5,000 hrs
additional, above 5,000 hrs
100
35
60
70
Supervision up to 2,500 hrs

additional each extra 600 hrs up to 4,900 hrs
additional, above 4,900 hrs
Power variable up to 3,600 hrs
for hrs above 3,600 additional cost,
400
100
150
0.25
0.20
Depreciation up to 5,000 hrs

above 5,000 hrs.
650
820
Clearing up to 4,000 hrs

above 4,000 hrs
Lighting
60
80
2,100 to 3,500 hrs

3,501 hrs to 5,000 hrs
above 5,000 hrs
120
150
175
(a) Prepare fixed budget and a flexible budget at 70%, 85% and 110% of budgeted level of
activity in one statement.
(b) Calculate a departmental hourly rate of overhead absorption.
Solution
Particulars
a. Capacity
b. Hours
Indirect wages @ Rs. 40/hr.
Rates & taxes
Flexible budget
70%
85%
3,500
4,250
Rs. 000
Rs. 000
140
170
320
320
110%
5,500
Rs. 000
220
320
Fixed budget
100%
5,000
Rs. 000
200
320
Cost Academy
Consumable supplies
@ Rs. 24/hr.
Repair
Supervision
84
402
205
300
(100+353)
(100+354+60)
600
700
132
120
370
300
56
(100+354+60+70)(100+354+60)
950
950
(3,50025) (3,60025+65020) (3,60025+1,90020) (3,60025+1,40020)
Power
Depreciation.
2.
87.5
650
103
650
128
820
118
650
Clearing
60
80
80
80
Lighting
120
150
175
150
Total cost
2,266.5
2,575
3,195
2,788
Absolute terms
647.57
605.88
580.91
517.6
Rate/month
0.647
0.605
0.58091
0.5776
From the information given below prepare a flexible budget of M/s piston Bearings Ltd. for a
production capacity of 15,00,000, 25,000 and 30,000 tonnes.
(a) The production capacity of the plant is 30,000 tonnes.
(b) The sales for the year just concluded have been 25,000 tonnes at a unit realization of Rs.
400 per tonne ex-works. This rate is likely to be maintained in the coming year as well.
(c) The sales manager feels that with a little more effort on the part of the sales staff, he can
achieve a sales programme of 30,000 tonnes.
(d) Raw material consumption is twice the quantum of finished products and the price of raw
material is Rs. 40 per tonne.
(e) The other major material used is furnace oil which is available at Rs. 300 per tonne and the
consumption ratio of oil to the finished products is 30%.
(f) Power is bought outside from the State Electricity Board and a per present tariffs, the cost of
power would be as under:
Kwh purchased per
Annum (in lakhs)
25 to 30
31 to 35
36 to 40
41 to 45
over 45
Rent per unit

(applicable to entire purchase-in paise)
15
14
13
12
10
Power requirements of the plant are normally 200 kwh per tonne of product at a production
level of 20,000 tonnes and are estimated to come down to 173 kwh per tonne at a
production level of 25,000 tonnes per annum and 150 kwh per tonne at 30,000 tonnes per
annum. Similarly, the consumption is expected to be 220 kwh per tonne at a production
level lower than 20,000 tonne p.a.
(g)
Labour is employed on a daily rate basis of Rs. 10 per day on an employment of 300 days
p.a. There are at present 350 men employed and though lower production would result in
some 20% of them being rendered surplus, because of an agreement with the labour union,
there cannot be any retrenchment.
(h)
Consumption of stores during the last four years had been as under:
Year
production level
stores consumed
1984
25,000 tonnes
Rs. 5,20 lakhs
Cost Academy
1983
1982
1981
20,000 tonnes
22,500 tonnes
25,000 tonnes
57
3.84 lakhs
3.95 lakhs
4.00 lakhs
Prices over the base year 1981 have been increasing at the rate of 10% p.a. in the current
year, the increases is expected to be maintained at the same rate over the prices of 1984.
(i)
Selling and distribution overheads are expected to be maintained at Rs. 15 per tonne.
(j)
Administrative expenses of the organization in 1981 were Rs. 7.50 lakhs and have been
increasing at the rate of 5% p.a. over the immediately preceding years level. No additional
staff is expected to be employed for achieving addition production.
Your working should form part of the answer.
Solution
M/s Piston Bearings Ltd.
Flexible Budget For 1985
Production (tonnes)
15,000
20,000
25,000
Rs.
Rs.
Rs.
Raw Materials
12,00,000
16,00,000
20,00,000
Furnace oil (see note 1)
13,50,000
18,00,000
22,50,000
Power (see note 2)
4,62,000
5,20,000
5,25,000
Labour
10,50,000
10,50,000
10,50,000
Stores (see note 3)
3,43,200
4,57,600
5,72,000
Factory cost
44,05,000
54,27,600
63,97,000
Administrative overhead (note 4) 9,11,630
9,11,630
9,11,630
Selling & Distribution overheads 2,25,000
3,00,000
3,75,000
Cost of sales
55,41,830
66,39,230
76,83,230
Net profit
4,58,170
13,60,770
23,16,370
Sales
60,00,000
80,00,000 1,00,00,000
30,000
Rs.
24,00,000
27,00,000
5,40,000
10,50,000
6,86,400
73,76,400
9,11,630
4,50,000
87,38,030
32,61,970
1,20,00,000
Working Notes:
1. Furnace oil is 30% of the finished product. For example, for the production of 15,00,000
tonnes; 4,500 tonnes, of furnace oil will be re required. The cost is Rs. 300 per tonne.
2. Power requirements are:
(i)
Capacity (in tonnes)
15,000
25,000 30,000
(ii)
Total requirements per tonne 220
200
(iii)
Total requirements (in kwh)
33,00,000
43,75,000
45,00,000
(iv)
Rate per kwh (paise)
14
12
12
(v)
Total power cost
Rs. 4,62,000
5,40,000
3.
170
5,20,000
Consumption of stores:
Cost per tonne in 1984 =
Rs.5,20,000
= Rs. 20.8 per tonne
25,000
Price has increased by 10% over 1984

Price for 1985 is Rs. 20.8+2.08 = Rs. 22.88 per tonne
Cost of stores at various levels of capacity:
Cost Academy
Levels of capacity (tonnes)
30,000
Cost per tonne (Rs.)
22.88
Total cost (Rs.)

15,000
20,000
22.88
22.88
3,43,200 4,57,000
58
5,72,000
4.
Administration expenses for 1981:

Increase in 1982 at 5% over preceding year
Expenses for 1982
Increase in 1983 at 5%
Expenses for 1983
Expenses for 1984
Estimated expenses
Rs. 7,50,400
37,500
7,87,500
39,375
8,26,875
41,344
8,68,219
43,411
9,11,630
3.
A company is engaged in the manufacture of specialized sub-assemblies required for certain

electronic equipments. The company envisages that in the forthcoming month, December, 1998,
the sales will take a pattern in the ratio of 3:4:2 respectively of sub-assemblies, ACB, MCB and
DP.
The following is the schedule of components required for manufacture:
Component requirements
Sub-assembly
Selling price
Base board
IC08
IC12
IC26
ACB
520
1
8
4
2
MCB
500
1
2
10
6
DP
350
1
2
4
8
Purchase price
Rs. 60
20
12
8
The direct labour time and variable overheads required for each of the sub-assemblies are:
Labour hours per sub-assembly
Grade A
Grade B
Variable overheads
Per sub-assembly
Rs.
ACB
8
16
36
MCB
6
12
24
DP
4
8
24
Direct wages rate per hour Rs. 5
4
-The laborers work 8 hours a day for 25 days a month.
The opening stocks of sub-assemblies and components for December, 1998 are as under:
Sub-assemblies
ACB
800
MCB
1,200
DP
2,800
Components
Base Board
IC08
IC12
IC26
1,600
1,200
6,000
4,000
Fixed overheads amount to Rs. 7,57,200 for the month and a monthly profit target of Rs. 12
lakhs has been set.
Cost Academy
59
The company is eager for a reduction of closing inventories for December 1998 of subassemblies and components by 10% of quantity as compared to the opening stock. Prepare the
following budgets for December 1998:
(i)
(ii)
(iii)
(iv)
(v)
Sales budget in quantity and value

Production budget in quantity
Component usage budget in quantity.
Component purchase budget in quantity and value.
Manpower budget showing the number of workers and the amount of wages payable.
Solution
Working note:
1.
Statement showing contribution:
Sub-assemblies
ABC
Rs.
Selling price per unit
Marginal cost p.a.
Components
Base board
60
IC08
160
IC12
48
IC26
16
MCB
Rs.
520
DP
Rs.
500350
60
40
120
48
60
40
48
64
Labour:
Grade A
40
30
Grade B
64
Variable production overhead
36
Total marginal cost p.u.: (B)
424
Contribution p.u.: (C) = (A B)
96
Sales ratio : (D)
3
ContributionSales ratio: [(E) =(CD)]288
20
48
24
370
130
4
520
Total
Rs.
32
24
288
62
2
124
932
2.
Desired Contribution for the forthcoming month December, 1998

Rs.
Fixed overheads
7,52,200
Desired profit
12,00,000
Desired contribution
19,57,200
3.
Sales mix required i.e. number of batches for the forthcoming month December, 1998
Sales mix required = Desired contribution/contributionSales ratio
= Rs. 19,57,200/932 (Refer to working notes 1 & 2)
= 2,100
Budgets for December 1998
(i)
Sales budget in quantity and value
Sub-assemblies
ACV
MCB
DP
Sales (qty.) (2,1003:4:2)
6,300
8,400
4,200
(Ref. To working note 3)
Selling price p.u. (Rs.)
520
500
350
Sales value (Rs.)
32,76,000 42,00,00014,70,000
(ii)
Sub-assemblies
ACB
Sales 6,300
8,400
Add: closing stock 720
(Opening stock less 10%)
Production budget in quantity

MCB
DP
4,200
1,080
2,520
--------- -----------------
Total
89,46,000
Cost Academy
Total quantity required
Less: Opening stock
Production
6,220

7,020
__800
8,280
60
9,4806,720
1,2002,800
3,920
(iii)
Component usage budget in quantity
Sub-assemblies
ACV
MCB
DP
Total
Sales
6,220
8,280
3,920
Base board (1 each)
6,220
8,2803,920 18,420
Component IC08 (8:2:2)
49,760 16,5607,840 74,160
(6,2204) (8,2802)
(3,9202)
24,880 82,80015,6801,23,360
(6,2204) (8,28010)
(3,9204)
12,440 49,68031,360 93,480
(6,2202) (8,2806)
(3,9208)
(iv)
Component purchase budget in quantity & value
Sub-assemblies
Base board
ACV
MCBDP
Total
Usage in production
18,420 74,1601,23,36093,480
Add: closing stock 1,440
1,080
5,4003,600
(Opening stock less 10%)
_______
19,860
75,240
1,28,76097,080
Less: Opening stock
___1,6001,20016,000 4,000
Purchase (Qty.)
18,260
74,0401,22,760
93,080
Purchase price (Rs.)
6020
128
Purchase value (Rs.)
10,95,60014,80,00014,73,120
7,44,64047,94,160
(v)
Manpower budget showing the number of workers & the amount of wages payable
Direct Labour____________
Grade A
Grade B
SubBudgeted
Hours per
Total
hours per
total
Total
Assemblies
production
units
hours
units
hours
ACB 6,220
849,760
16
99,520
MCB 8,280
649,680
12
99,360
DP
3,920
415,680
8
31,360
(A) Total hours
1,15,120
2,30,240
(B) Hours per man per month
200
200
(C) Number of workers per month: (A/B)
576
1,152
(D) Wage rate per month (Rs.)
1,000
800
(E) Wages payable (Rs.) : (CD)
5,76,000 9,21,600
14,97,600
4.
X Manufacturing company takes over sales from the Selling Agents. In the first month of
operation of direct sales, the following costs have been incurred. Prepare the actual percentage
of selling cost on total sales, compare with the standard selling cost.
Compute the variances and offer your comments about the standards, which are based on actual
for the previous year, and performance of the Zonal offices.
Zonal offices
Sales Budgets (units)
Eastern India
20,000
Western India
12,000
Northern India
6,000
Southern India
15,000
Central India
10,000
Northern Western India
5,000
Selling price per unit Rs. 25
Standard selling expenses

Rs. 16,000
12,000
8,000
12,000
10,000
8,000
Cost Academy
Actual:
E.I.
Units sold (000 units)
19
Salesmens salaries (Rs.000) 8
Sales travelling (Rs.000)
4
Halting charges &
Bhatta (Rs.)
850
Salesmens commission
On selling prices @ 1%
1.25%
1%
0.9%
1%
61
W.I.
10
7
5
N.I.
5.9
5
3.6
S.I.
17.5
7
2.7
C.I.
9.5
6
2.7
N.W.I
5
5
1.8
800
500
500
700
500
Solution
COMPARATIVE COST STATEMENT OF SELLING EXPENSES
E.I.
W.I.
N.I.
S.I.
C.I.
N.W.I.
Standard
1. Selling exp. (Rs.)
16,000
2. Budgeted sales (units)20,000
3. Selling cost p.u.
Rs. (1)(2)
0.80
4. Actual sales (units)
19,000
5. Standard selling cost
for actual sales (Rs.) ______
(3)(4)
15,200
Actual selling costs:
Salesmens
salaries (Rs.)
8,000
Sales travelling
4,000
Halting charges etc.
850
Salesmens
commission
4,750
6. Total actual selling _______
costs
17,600
7. selling costs variance
Rs. (5) (6)
- 2,400
8. Budgeted sales
(Budgeted qty. budgeted
price) (Rs.)
5,00,000
9. Budgeted selling
expenses as a %
of Budgeted sales
(1)(8)100
3.2
10. Actual sales (Rs.) 4,75,000
11. Actual selling
expenses as a % of
actual sales
3.7
12,000
12,000
8,000
6,000
12,000
15,000
10,000
10,000
8,000
5,000
1.00
10,000
1.33
5,900
0.80
17,500
1.00
9,500
1.60
5,000
_______
10,000
______
__7,897
_______
_14,000
______
_9,500
_______
__8,000
7,000
5,000
800
5,000
3,600
500
7,000
2,700
500
6,000
2,700
700
5,000
1,800
500
3,125
_______
15,925
1,475
_______
_10,575
3,937
_______
14,137
2,375
________
_11,775
1,250
_______
_8,550
- 5,900
- 2,708
- 137
- 2,275
- 550
3,00,000
1,50,000
3,75,000
2,50,000
1,25,000
4.0
2,50,000
5.3
1,47,500
3.2
4,37,500
4.0
2,37,000
6.5
1,25,000
6.4
3.2
7.2
4.9
6.8
Comments: The above table shows that except for southern India and North western India
Zonal offices, actual sales expenses widely differ from budgeted selling expenses. However, the
following points have to be noted:
(i) The standards are based on the actual expenses for the last year. Truly speaking they are
not standards and, therefore, they cannot provide realistic guidance for exercising control over
the selling expenses. Variances may be there because current years conditions might have
completely changed or circumstances which were applicable last year may have ceased to
become applicable now.
Cost Academy
(ii)
62
The causes of the variances cannot be correctly spelt out in the absence of details about the
Standard selling expenses. The details of actual selling expenses have been given but the
details of standard selling expenses have not been given. Salesmens salaries is a fixed charge,
variance may be there on account of increase in their salaries. Sales travelling expenses are of
a semi-variable nature. Less volume of sales might have resulted in less recovery of fixed sales
travelling expenses such as railway freight, hotel charges.
On Standard Costing
1.
Nina Garcia is the newly appointed president of Laser Products. She is examining the May 2009
results for the Aerospace products Division. This division manufactures wing parts for satellites.
Garcias current concern is with manufacturing overhead costs at the Aerospace products
Division. Both variable and fixed manufacturing overhead costs are allocated to the wing parts on
the basis of laser-cutting hours. The following budget information is available:
Budgeted variable manufacturing overhead rate
Budgeted fixed manufacturing overhead rate
Budgeted laser-cutting time per wing part
Budgeted production and sales for May 2007
Budgeted fixed manufacturing overhead costs for May 2007
Rs. 200 per hour.

Rs. 240 per hour.
1.5 hours
5,000 wing parts
Rs. 18,00,000
Actual results for May 2009 are:

Wing parts produced and sold
Laser-cutting-hours used
Variable manufacturing overhead costs
Fixed manufacturing overhead costs
4,800 units
8,400 hours
Rs. 14,78,400
Rs. 18,32,200
Required:
1. Compute the spending variance and the efficiency variance for variable manufacturing
overhead.
2.
Compute the spending and the production-volume variance for fixed manufacturing
overhead.
3.
Given two explanations for each of the variances calculated in requirements 1 & 2.
Solution
1 and 2 see Exhibit
Cost Academy
63
Columnar presentation of integrated variance analysis: Laser products for May 2009
2.
a. Variable manufacturing overhead spending variance, Rs. 2,01,600 F. One possible reason
for this variance is that actual prices of individual items included in variable overhead (such
as cutting fluids) are lower than budgeted prices. A second possible reason is that the
percentage increase in the actual qty. usage of individual items in the variable overhead cost
pool is less than the percentage increase in laser-cutting-hours compared to the flexible
budget.
b. Variable manufacturing overhead efficiency variance, Rs. 2,40,000 U. One possible reason
for this variance is inadequate maintenance of laser machines, causing them to take more
laser-cutting time per wing part. A second possible reason is use of under motivated,
inexperienced, and under skilled workers with the laser-cutting machines, resulting in more
laser cutting time per wing part.
c.
Fixed manufacturing overhead spending variance, Rs. 32,200 U. One possible reason for
this variance is that the actual prices of individual items in the fixed-cost pool unexpectedly
increased from the prices budgeted (Such as an unexpected increase in machine leasing
costs). A second possible reason is misclassification of items as fixed that are in fact
variable.
d. Production-volume variance, Rs. 72,000 U. Actual production of wing parts is 4,800 units,
Compared with 5,000 units budgeted. One possible reason for this variance is demand
factors, such as a decline in an aerospace program that led to a decline in demand for
aircraft parts. A second possible reason is supply factors, such as a production stoppage due
to labour problems or machine breakdowns.
On Learning Curve
1.
The Helicopter Division of GLD inc is examining helicopter assembly costs at its plant in
Marseilles, France. It has received an initial order for eight of its new land surveying helicopters.
Aerospatiale can adopt one of two methods of assembling the helicopters;
Labour intensive
Assembly method
Rs.
Direct material cost per
Helicopter
Direct assembly labour
Time for first Helicopter
Learning curve for assembly
Labour time per helicopter
time
Direct assembly labour cost
Equipment-related indirect
Manufacturing cost
Materials-handling related
Indirect manufacturing cost
40,000
2,000 labour-hours
85% cumulative avg. time
30 per hour
12 per direct assembly
Labour hour
50% of direct material cost
Machine intensive
Assembly method
Rs.
36,000
800
labour-hours
90%
incremental
unit
30
per hour
45
per direct-assembly
labour hour
of D. material cost
50%
Using the formula (p 350), for an 85% learning curve, b = in 0.85 in 2

= -0.162519 0.693147
= -0.234465
Cost Academy
Using the formula (p 351) for a 90% learning curve, b
64
= in 90 in 2
= -0.1053610.693147
= -0.152004
Required:
1. How many direct-assembly labour-hours are required to assemble the first eight helicopters
under (a) the labour-intensive method and (b) the machine-intensive method?
2. What is the total cost of assembling the first eight helicopter under (a) the labour-intensive
method and (b) the machine intensive method?
Solution
1.
a. The following calculations show the labour-intensive assembly method based on an 85%
cumulative average-time learning model
Cumulative no. Cumulative average time per unit (y): Cumulative
total Incremental time
of units
labour hours
time: Labour hours for Xth unit:
(3) = (1 2)
Labour hours
(1)
(2)
(4)
Col j = col GCol
H
1
2,000
2,000
2,000
2
1,700
(2,0000.85)
3,400
1,400
3
1,546
4,637
1,237
4
1,445
(1,7000.85)
5,780
1,143
5
1,371
6,857
1,077
6
1,314
7,884
1,027
7
1,267
8,871
987
8
1,228.25
(1,4450.85)
9,826
955
Cumulative average-time per unit for the Xth unit in column H is calculated as y = aXb; see
Exhibit 10-10. for example, when X = 3, y= 2,000 3-0.234465 = 1,546 labour hours.
b. The following calculations show the machine intensive assembly method based on a 90%
incremental unit-time learning model:
Cumulative no. Individual unit time for Xth unit (y):
of units
labour hours
1
2
3
4
5
6
7
8
800
720
677
648
626
609
595
583
(8000.9)
(7200.9)
(6480.9)
Cumulative total Cumulative

time:
Labour average time per
hours
unit:
Labour hours
(4)
Col K = Col J
Col G
800
800
1,520
760
2,197
732
2,845
711
3,471
694
4,081
680
4,676
668
5,258
657
Individual unit time for the Xth unit in column H is calculated as y = aX b . for example, when X =
3, y = 800 3 -0.152004 = 677 labour hours.
2.
Total costs of assembling the first eight helicopters are:

Labourintensive
Assembly
Method
Machine-intensive
Assembly method
(using data from
part 1b)
Cost Academy
65
(Using data
from part 1a)
Col K = Col J
Col G
Direct Materials:
8 helicopters Rs. 40,000; Rs. 36,000 per helicopter
Direct-assembly labour:
9,826 hours; 5,258 hrs. Rs. 30/hr.
Indirect manufacturing costs
Equipment related
9,826 hrs. Rs. 12/hr.; 5,258 hrs. Rs. 45/hr.
Materials-handling related
0.50 Rs. 3,20,000; 2,88,000
Total assembly costs
3,20,000
2,88,000
2,94,780
1,57,740
1,17,912
2,36,610
1,60,000
Rs. 8,92,692
1,44,000
8,26,350
The machine intensive methods assembly costs are Rs. 66,342 lower than the labour intensive
method (Rs. 8,92,692 Rs. 8,26,350)

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Cost Academy

Advanced Management Accounting

10F, Shyama Prasad Mukherjee Road

: (033) 2486- 4919 & 2419-1631

Only Study ( planning & questions) purposes:

Advanced Management Accounting

Some additional very important problems &

Advanced Management Accounting

1. Problem on Transfer Pricing004

Advanced Management Accounting

Problem on Transfer pricing

Incremental cost per crankshaft in Machining Div. (Rs.) 190

External suppliers market price per crankshaft (Rs.)

Opportunity costs of the machining division supplying

Advanced Management Accounting

Total purchase costs if buying from an external Supplier

Incremental costs of buying from the Machining

Total opportunity costs of the Machining Div.

Advanced Management Accounting

Advanced Management Accounting

On Activity Base Costing

Direct labour cost (Rs.)

The overheads of the receiving department are recovered by a materials handling

(b) Compute product costs using an activity-based costing system.

Advanced Management Accounting

= Rs. 21 per direct labour hour.

Working note: Overheads to be charged to products:

= 35.14% of direct material

Advanced Management Accounting

Rs.1,000 x3 Rs.1,000 x 7 Rs.1,000 x 20

(Ref. To working note 2 (i))

Rs.1,611x15 Rs.1,611x35 Rs.1,611x 200

(Ref. To working note 2(ii))

Rs.7,812 x9 Rs.7,812 x3 Rs.7,812 x 20

(Ref. To working note 2 (iii))

Rs.7,460 x15 Rs.7,460 x10 Rs.7,460 x 25

(Ref. To working note 2 (iv))

Total manufacturing cost

Advanced Management Accounting

Variable overhead cost is Rs.1,500,000 of which 40 percent is related to the acquisition,

Direct labour related

Direct material related

Advanced Management Accounting

Unit costs based on activity-based costing

Lab. Related overheads/op

Rs. 600,000_____________ = Rs. 6.67/kg

Unit costs based on ABC

Advanced Management Accounting

Hours per unit

Costs relating to set-up

Advanced Management Accounting

ABC cost per unit

Total cost per unit

Advanced Management Accounting

Activities per 1000 units

Advanced Management Accounting

Rs.10,430 + Rs.5250 + Rs.3600 + Rs.2100 + Rs.4620

Cost per unit